The average collection period (ACP) of a company refers to the average number of days it takes to convert receivables into cash. It’s also known as days sales outstanding.
In other words, it’s the average number of days company’s customers/clients takes to pay their bills or number of days taken by the company to collect invoiced amount from customers.
Average collection period can be compared with the company’s credit policy to know exactly how effective is the company’s collection. It tells the stakeholders the liquidity of company’s accounts receivables.
Accounts receivable is the amount that all customers owe to the company. ACP shows how quickly a company converts accounts receivable into cash.
Here is the formula to calculate ACP:
ACP = receivables turnover * 365 = (average accounts receivables/ total credit sales ) * 365
You can use 360 days instead of 365 days. 365/360 days is considered when you calculate ACP for the whole year. If you want ACP to be calculated for a quarter then use 90 days instead of 365/360.
Average account receivable can be calculated by adding opening balance plus closing balance of receivables and then by dividing the resulting figure by 2.
Total credit sales is calculated after taking out returns from gross credit sales.
What average collection period (ACP) indicates
A short ACP indicates that the credit policy of the company is effective and it manages customer effectively.
A long ACP indicates that company’s credit policy is not effective and the company should tighten it to improve its liquidity position.
Example to calculate ACP
Suppose company XYZ has total credit sales of Rs. 1,00,000 and the opening and closing accounts receivable balance for the year is Rs 12,000 and 8,000 respectively.
To calculate ACP, first thing we have to find out is average accounts receivables.
Average accounts receivable = (12,000+8,000)/2 = Rs. 10,000
Receivable turnover = average accounts receivable/ credit sales = 10,000/1,00,000 = 1/10
Therefore, ACP = 365 * 1/10 = 36.5 days
This means company XYZ’s customers pay their dues every 36.5 days on average. If average collection period as per credit policy is more than 36.5 days, then company has a effective management to collect the money dues.
You should always compare this figure with the previous year’s figures to have more clarity. It will tell you how the company is improving its ACP over the years.
If ACP in comparison to previous year figures is increasing, then it means your accounts receivable is losing liquidity and you may have to take necessary steps to reverse the trend.
Following actions might help you to have a better average collection period:
- Having a clear and tighten credit policy.
- Making your credit terms clearer to your customers.
- Using attractive discount period to clear pending dues in time.
- Have a better follow-up mechanism.
- Charge interest on credit if it exceeds your allowed period limits.
ACP varies industry to industry, but in all cases, the shorter is better.