Introduction
The average collection period is the time a business would take in order to start receiving payments that are due for payment to its clients. This is considered as the account receivable (AR). Business entities will calculate the average collection period in order to ensure that they are left with sufficient money in hand to fulfil all their fiscal commitments.
The average collection period is obtained by the ratio of the average balance of accounts to the total net credit sales for the period and obtaining its product along with the total number of days in that period. The average collection period is one of the most critical factors for those business entities who depend extensively on accounts receivable for the cash inflows.
Breaking Down Average Collection Period
The average collection period depicts the average number of days between the date on which the buyer pays for his or her purchase of goods and the date on which the purchase amount is paid. A business entity’s average collection period indicates the efficiency of its accounts receivable mechanism. Therefore, business entities should be in a position to handle their average collection period so that their operations are not affected in any way.
Implications
A lower average collection period is typically more favourable as compared to a higher average collection period. A lower average collection period shows that the business is able to collect payments much faster than others. However, like everything, a lower average collection period also has some drawbacks.
The customers may feel the business has strict credit guidelines and hence, may seek to do business with that company which has a higher average collection period and more flexible payment terms and conditions. Therefore, it is important to carefully deliberate on the payment terms by considering all business factors.
