Average Collection Period

The average collection period measures how many days it typically takes a company to collect cash after making a sale on credit. It is also commonly called days' sales in accounts receivable, and the two names describe exactly the same calculation and the same underlying question: how long is cash tied up in receivables before customers actually pay?

The most common formula divides 365 by the accounts receivable turnover ratio, which itself is calculated as credit sales divided by average accounts receivable. A company whose receivables turn over 10 times a year has an average collection period of roughly 36.5 days, meaning that, on average, a dollar of credit sales takes about five weeks to turn into cash in the bank.

The average collection period is most useful when compared against the credit terms a company actually offers its customers. A business extending 30-day credit terms that finds its average collection period running at 45 days is effectively allowing customers an extra two weeks of free financing beyond what was agreed, a gap that directly ties up working capital that could otherwise be used elsewhere in the business. A collection period close to or below the stated terms suggests customers are generally paying on time and collections efforts are effective.

A lengthening average collection period can reflect looser credit approval standards, a weaker collections process, customers facing their own cash flow problems, or simply a deliberate strategic decision to extend more generous terms to win market share from competitors. A shortening collection period usually reflects tighter credit policies or more aggressive collections, though pushed too far it can also start costing a business sales from customers who would have preferred, and could have afforded, slightly longer terms.

Lenders assessing a company's working capital needs, and investors judging the quality of reported earnings, both track the average collection period over time because a steadily rising figure is one of the earliest warning signs of either deteriorating customer credit quality or revenue that is being recognized more aggressively than cash is actually being collected. Comparing the average collection period against close industry peers is also standard practice, since acceptable collection periods vary enormously between, for example, a cash-heavy retailer and a business-to-business supplier that routinely extends 60- or 90-day terms to large corporate customers.

A company with $600,000 in credit sales and average accounts receivable of $75,000 has an accounts receivable turnover of 8, producing an average collection period of about 45.6 days (365 divided by 8). If that same company's stated credit terms are net 30, the 45.6-day result shows customers are, on average, paying more than two weeks later than agreed, a gap worth investigating before it widens further.

A single average collection period figure is less useful than tracking it over several quarters or years, since a steadily lengthening collection period is one of the earliest warning signs that customers are under financial stress, that credit terms are being granted too loosely to win sales, or that collections staff are falling behind. Seasonal businesses also need to be careful comparing one quarter's average collection period against another, since a quarter with unusually high sales late in the period can mechanically shorten the apparent collection period even if underlying customer payment behavior has not actually improved, which is why analysts often compare the same quarter year over year rather than sequential quarters within a single year.