Average Accounts Receivable

Average accounts receivable is the typical balance of a company's accounts receivable during a period of time, such as a year or a quarter. The simplest measure is the average of the balances at the beginning and end of the period, though analysts with access to monthly figures prefer the average of all month-end balances. It is used mainly as the denominator in the accounts receivable turnover ratio and related collection measures.

Using an average rather than a single year-end figure matters because turnover compares a flow, credit sales for the whole period, with a stock, the receivables balance. A balance taken on one day may be unusually high or low, especially for seasonal businesses. Averaging smooths out some of that distortion and gives a fairer picture of how much credit the company has been carrying.

Imagine a corner shop that lets regular customers run a tab. On some days the tabs add up to $500; on other days, after people have paid, only $200. If the owner wants to know how much money is usually tied up in tabs, the honest answer is not the figure on any one day, but a typical amount across the year.

Average accounts receivable is that typical amount for a business. Comparing it with total credit sales shows how quickly customers pay and how much cash is waiting to come in.

The basic calculation is:

A wholesaler begins the year with net receivables of $340,000 and ends with $420,000. Average accounts receivable is ($340,000 + $420,000) ÷ 2 = $380,000. If credit sales for the year were $3,040,000, receivables turnover is $3,040,000 ÷ $380,000 = 8 times. The average collection period is then 365 ÷ 8, or about 46 days.

Where monthly balances are available, adding the 13 month-end balances from the opening balance through December and dividing by 13 gives a better average, because it captures peaks and troughs during the year.

Most analysts use receivables net of the allowance for doubtful accounts, which is the amount shown on the balance sheet as accounts receivable, net. Internal credit managers sometimes prefer gross receivables, which reflect what customers actually owe before estimated bad debts. Either can be defended, but the same choice must be used consistently when comparing periods or companies. Receivables from employees, officers or tax refunds are excluded, because they do not arise from sales.

• Turnover and collection speed. Average receivables underlies receivables turnover, days sales outstanding and the days' sales in accounts receivable measure.
• Working capital planning. A rising average relative to sales ties up more cash in working capital and may require borrowing.
• Credit policy review. A company that loosens its credit terms to win sales should expect average receivables to grow faster than sales.
• Quality of revenue. Receivables that grow much faster than revenue can indicate collection problems or aggressive revenue recognition.

A two-point average can still mislead. A retailer with a December year end may have a small receivables balance on both January 1 and December 31, but very large balances in October and November; its true average is far higher than the two-point figure suggests, which overstates turnover. Acquisitions during the year also distort the average, because the ending balance includes the acquired company's receivables while sales include only part of a year. Analysts should note such events and, where possible, use monthly or quarterly data. Write-offs matter as well: a company that writes off old balances aggressively, recording the losses through bad debts expense, will show a smaller average and faster turnover than a company that keeps doubtful accounts on its books, even if their customers pay at the same speed. Comparisons across industries need care too, since normal credit terms vary widely, from a few days in retail to 60 or 90 days in some business-to-business sectors. As with any measure used in ratio analysis, the figure is most useful when tracked over several periods for the same company.