What it is — plain definition
– The average collection period (ACP) estimates how many days, on average, a company takes to turn credit sales into cash. It measures the typical time between invoicing a customer and receiving payment and is used to monitor accounts receivable (AR) performance and short‑term liquidity.
Key terms (defined)
– Accounts receivable (AR): money owed to the company by customers for goods or services sold on credit. AR appears as a current asset on the balance sheet.
– Net credit sales: sales made on credit during a period, after deducting returns, discounts and allowances. Cash sales are excluded.
– Receivables turnover ratio: how many times receivables are collected over a period. It links directly to ACP.
– Days sales in receivables: another name for ACP (expressed in days).
Why it matters
– ACP helps management ensure enough cash is available to meet obligations.
– It signals how well a firm manages credit and collections.
– Compare ACP over time, against stated payment terms (e.g., net 30), or versus competitors in the same industry to spot problems or improvements.
– Lower ACP is generally desirable (faster collections), but an excessively low ACP can indicate overly tight credit that may push customers away.
Formulas (two equivalent forms)
1) ACP (days) = Days in period × (Average accounts receivable / Net credit sales)
– Most often Days in period = 365 for yearly data.
2) ACP (days) = Days in period / Receivables turnover ratio
– Where Receivables turnover = Net credit sales / Average accounts receivable
How to calculate — step-by-step
1. Select the time period (e.g., full fiscal year). Use the same period for sales and receivables.
2. Compute average AR = (Beginning AR + Ending AR) / 2. (Note: some systems use daily balances for more precision.)
3. Determine net credit sales for the same period (exclude cash sales; deduct returns, discounts, allowances).
4. Plug into formula 1 or compute receivables turnover and use formula 2.
5. Interpret the result relative to company credit terms, historical trend, and industry peers.
Checklist — what to gather and watch for
– Beginning and ending accounts receivable balances for the chosen period.
– Net credit sales for the same period (exclude cash sales).
– Confirm you’re using the same time span for both figures.
– Note seasonal swings: peak vs. slow months can distort averages.
– Decide whether to use 365 (annual) or the actual number of days in the period.
– Compare ACP to stated payment terms (e.g., net 30) and to industry norms.
Worked numeric example
Assumptions:
– Average accounts receivable during the year = $10,000
– Net credit sales for the year = $100,000
– Use 365 days for the year
Method A (direct formula):
ACP = 365 × (Average AR / Net credit sales)
ACP = 365 × (10,000 / 100,000) = 365 × 0.10 = 36.5 days
Method B (via turnover):
Receivables turnover = Net credit sales / Average AR = 100,000 / 10,000 = 10
ACP = 365 / Receivables turnover = 365 / 10 = 36.5 days
Interpretation: On average the company collects about 36.5 days after a credit sale. If invoices are normally due in 30 days, this suggests collections are slower than terms; if terms are net 45, this performance is acceptable.
Common pitfalls and assumptions
– Don’t mix periods (e.g., use a year’s sales with only a month’s receivable balances).
– Exclude cash sales; include only credit sales in net credit sales.
– Seasonal businesses may need rolling averages or shorter comparable periods.
– Using beginning and ending AR is a simplification; daily averages are more precise if available.
Ways companies commonly try to improve ACP
– Invoice promptly and accurately.
– Offer modest early‑payment discounts (e.g., 2/10 net 30).
– Strengthen credit checks and set appropriate limits.
– Automate reminders, collections, and online payment options.
– Consider receivables financing (factoring) for immediate cash, with cost tradeoffs.
Quick use cases
– Internal control: track ACP monthly to spot worsening collections early.
– Benchmarking: compare ACP with peers in the same industry.
– Cash planning: estimate cash inflows by translating outstanding AR into expected collection timing.
Sources
– Investopedia — Average Collection Period: https://www.investopedia.com/terms/a/average_collection_period.asp
– Corporate Finance Institute — Average Collection Period: https://corporatefinanceinstitute.com/resources/knowledge/finance/average-collection-period/
– AccountingTools — What Is the Average Collection Period?: https://www.accountingtools.com/articles/what-is-the-average-collection-period.html
Educational disclaimer
This explainer is for educational purposes only. It is not personalized investment, accounting, or legal advice. Consult a qualified professional for decisions that affect your specific situation.