Average Collection Period Formula

Average Collection Period Formula (Table of Contents)

• Average Collection Period Formula
• Average Collection Period Calculator
• Average Collection Period Formula in Excel(With Excel Template)

Average Collection Period Formula

The formula for calculating Average Collection Period Formula is as follows:

Alternatively, collection period can also be calculated as –

Where,

The average collection period can be assumed as the Average number of days between the following:

• Date at which credit sales are made, and
• Date at which money has been received from the customers.

The average collection period can also be denoted as the Average days’ sales in accounts receivable.

Examples of Average Collection Period Formula

Let’s take an example to find out the Average Collection Period for a company:-

Average Collection Period Formula – Example #1

Jagriti Group of Companies books of accounts have the following details as per its financials for the year ended 2017-18

• Total sales = $2,00,000
• Cash sales = $70,000
• Closing Balance of Accounts receivables = $10,000
• Closing Balance of Notes receivables = $5,000

We have to calculate the Average collection period for Jagriti Group of Companies.

To calculate Average collection period, we need the Average Receivable Turnover and we can assume the Days in a year as 365.

We have calculated credit sales by using the below formula:

• Credit Sales = Total Sales – Cash Sales
• Credit Sales= $2,00,000 – $70,000
• Credit Sales= $1,30,000

We can calculate Receivables turnover ratio as follows:

• Receivables turnover ratio = Net credit sales / (Receivables + Notes receivables)
• Receivables turnover ratio = $1,30,000 / ($10,000 + $5,000)
• Receivables turnover ratio = $1,30,000 /$15,000
• Receivables turnover ratio = 8.7 or 9 Times

Now we can calculate the Average collection period for Jagriti Group of Companies by using the below Formula

• Average Collection Period Formula= 365 Days /Average Receivable Turnover ratio
• Average Collection Period = 365/9
• Average Collection Period = 40 Days

On an average, the Jagriti Group of Companies collects the receivables in 40 Days.

Average Collection Period Formula – Example #2

Anand Group of companies have decided to make some changes in their credit policy. In order to analyze the current scenario, they have asked the Analyst to compute the Average collection period.

Following details have been shared to the Analyst for calculating the Average collection period of the company–

• Net Credit Sales = $2,50,000
• Opening Balance of Accounts Receivables = $25,000
• Closing Balance of Accounts Receivables = $35,000

In the above case, Analyst have to calculate the average accounts receivable for Anand group of companies based on the above details

For calculating Average collection period, we need the Average Receivable Turnover and we can assume the Days in a year as 365.

And,

We have Opening and Closing accounts receivables Balances of $25,000 and $35,000 for Anand Group of companies.

• The average accounts receivables for the year = ($25,000 + $35,000) / 2
• The average accounts receivables for the year = $60,000 / 2
• The average accounts receivables for the year = $30,000.

Now, we can calculate Average Receivable Turnover by using formula:

• Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
• Accounts Receivable Turnover Ratio = $2,50,000 / $30,000
• Accounts Receivable Turnover Ratio = 8.3 or 8x.

Now, we can calculate the Average Collection period for Anand Group of companies using the below formula:

• Average Collection Period Formula= 365 Days /Average Receivable Turnover ratio
• Average Collection Period = 365/ 8
• Average Collection Period = 45.62 or 46 Days.

Anand Group of companies can make changes in its credit term depending on the collection period policy.

Average Collection Period Formula – Example #3

Let’s take an example Jagriti Company, Inc. have accounts receivable outstanding of $50,000 for the year beginning 2017. And, accounts receivable outstanding of $60,000 at the end of same financial year. Net Credit Sales for Jagriti Company Inc is for the same financial year is $600,000.

We can calculate the Average Accounts Receivable for the year by adding the Beginning and Ending Accounts receivables and dividing the total by 2. This brings the average accounts receivable for Jagriti Company, Inc as

• Average Accounts Receivable for the year = ($50,000+$60,000)/2
• Average Accounts Receivable for the year = ($110,000)/2
• Average Accounts Receivable for the year = 55,000

We can calculate the Average Collection period by using the below formula:

• Average Collection Period = 365 Days /Average Receivable Turnover ratio
•  Average Collection Period = 365/ ($600,000/$55,000)
• Average Collection Period=365/11
• Average Collection Period = 33 Days

Explanation

Average Collection Period can be calculated by using these formulas:

• Average Collection Period Formula= 365 Days /Average Receivable Turnover ratio
• Average Collection Period Formula= Average accounts receivable balance / Average credit sales per day

The first formula is mostly used for the calculation by investors and other professionals.

In the first formula to calculate Average collection period, we need the Average Receivable Turnover and we can assume the Days in a year as 365.

We can calculate the Average Accounts Receivable for the year by adding the Beginning and Ending Accounts receivables and dividing the total by 2.

We can calculate the Average Collection period by using the below formula:

Average Collection Period = 365 Days /Average Receivable Turnover ratio

For the second formula, we need to compute the average accounts receivable per day and the average credit sales per day. Average accounts receivable per day can be calculated as average accounts receivable divided by 365 and Average credit sales per day can be calculated as average credit sales divided by 365.

Significance and Use of Average Collection Period Formula

To get a more valuable insight into the business we must know the company’s Average Collection period ratio. But get a meaningful insight we can use the Average Collection period ratio as compared to other companies’ ratio in the same industry or can be used to analyze the trend of the previous year. This ratio shows the ability of the company to collect its receivables and also the average period is going up or down. The company can make changes in the collection policy to handle the liquidity of the business.

We can also compare the company’s credit policy with the competitors on the average days taken by the company from credit sale to the collection and can judge how well a company is doing.

If the company have an average collection period of 40 days, but the company has a credit policy to collect the receivables in 30 days, then there is a problem in the collection team of the company. In case the average collection period is 40 days and the company has announced a credit policy of 15 days, then this situation is significantly worse. The customers are not following the credit agreement terms, and this needs a look at your company’s credit policy and introducing measures to change the current scenario. Following measures can be taken for making the current scenario abiding:

• Require Tightening of credit.
• Instructing the customers on the credit terms.
• Offering Discount to the customers in case they are paying the credit in advance, offering 2 % discount in case customer paid in first ten days.
• Follow-Up with the credit team on delinquent accounts.
• Charging interest on delay on paying the account receivables.

Average Collection Period Calculator

You can use the following Average Collection Period Calculator

Average Collection Period Formula in Excel (With excel template)

Here we will do the same example of the Average Collection Period formula in Excel. It is very easy and simple. You need to provide the only one inputs i.e Average Receivable Turnover ratio

You can easily calculate the Average Collection Period using Formula in the template provided.

In, this template we have to solve the Average Collection Period Formula

First, we have calculated the Average Account Receivable

Here we have to Find out the Receivables Turnover Ratio

Here we have calculated the Average Collection Period

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