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The accounts receivable collection period is the time it takes a business to collect money from customers to whom it has extended credit. It affects cash flow and helps businesses determine if they need to adjust credit policies. Calculating the collection period allows managers to assess the amount of time a credit account remains open and make necessary adjustments. The basic way to calculate the average collection period is to take the outstanding balance of accounts receivable at the beginning and end of the year, divide by two, divide by net credit sales, and multiply by 365.
An accounts receivable collection period, also known as days on accounts receivable, is the average amount of time it takes a business to collect money from customers to whom it has extended credit. This calculation is particularly important because it affects a company’s anticipated cash flow. Businesses use the calculation of this collection period to determine if they need to make adjustments to their credit policies and terms to ensure that credit is extended only to reliable customers and that payments are made in a timely manner.
Part of a business‘s accounting process is keeping track of the credit it has extended to customers, known as accounts receivable. The accounts receivable process can be particularly complex because it involves company policies on when to extend credit and also manages the terms of extending credit. For example, a company might allow the extension of credit to customers with a certain minimum credit score and give them 12 months to pay their bill in full. Once the line of credit is approved, the accounts receivable department manages the account, including creating an accounting record for each credit customer, collecting and recording payments made, sending payment reminders, and assessment of late payment charges.
The decision to allow a customer an extended period of time to pay for the goods or services they receive immediately can put significant pressure on a business. Companies extending credit must have enough money in the bank to pay for inventory while they wait for customers to finish paying for products already in their possession. To effectively manage cash flow, a business must have a reasonable expectation of when money will come in. You should also have an idea of how your customers pay their bills.
Calculating a company’s accounts receivable collection period allows managers to assess the amount of time a credit account remains open. It helps them decide on a credit extension term that is long enough to entice customers to make a purchase, while not so long that the company cannot maintain inventory levels or pay invoices. Many companies keep track of the accounts receivable collection period and compare it to prior periods as an early indicator that changes in credit policies and conditions are needed. If the collection period increases, it may mean that the company should adjust its credit policies or arrange for additional inventory financing to offset the change in cash flow.
The basic way to calculate a company’s average collection period for accounts receivable is to take the company’s outstanding balance of accounts receivable at the beginning of the year and add it to the outstanding balance of accounts receivable at the end of the year. Divide the amount by two and divide the result by the company’s net credit sales. Multiply the result by 365, the number of days in a year. The solution is the average number of days that a credit account remains in accounts receivable during the year.
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