Measuring Average Collection
The average collection period measures the length of time it takes to convert
your average sales into cash. This measurement defines the relationship between accounts
receivable and your cash flow. A longer average collection period
requires a higher investment in accounts receivable. A higher investment in
accounts receivable means less cash is available to cover cash outflows, such as
The average collection period is calculated by dividing your present accounts
receivable balance by your average daily sales:
|Average Collection Period =
||Current Accounts Receivable Balance
Average Daily Sales
The average daily sales volume is computed by dividing your annual sales
amount by 360:
|Average Daily Sales =
Using the annual sales amount and accounts receivable balance from the prior
year is usually accurate enough for analyzing and managing your cash flow.
However, if more recent information is available, such as the previous quarter's
sales information, then use it instead. Be sure to compute the average daily
sales correctly using the number of days actually reflected in the sales figure
(e.g., 90 should be used if a quarterly sales amount is used).
David owns and operates an auto supply and repair shop.
David's total annual sales amount from the previous year was
$200,000. The total balance of his accounts receivable at the
end of the same year was $20,000. David's average collection
period is calculated as follows:
David's average daily sales volume is $556 per day:
The average collection period is 36 days:
For David's previous year, each dollar of sales was invested in accounts
receivable for 36 days. Assuming that David's business has not changed
drastically from last year, the cash inflows from sales on account will not be
available for cash outflow purposes for 36 days.
Now that you're acquainted with the average collection period, see our
discussion of how you can use
your average collection period to improve your cash flow.