Does your business accept credit sales? If so, you should probably be calculating the collection period for your business. The collection period, also known as the average collection period or the days’ sales in accounts receivable, is the average number of days between the date the credit sale occurs and the date when your business actually collects the money from that sale.
Another way you can look at the collection period is to think of it as the average number of days it takes to convert accounts receivable into actual cash. The collection period is a useful number to calculate because it tells you the liquidity of your business’s accounts receivable.
One way to calculate the collection period is to take 365 and divide it by your accounts receivable turnover. For example, if your business’s accounts receivable turnover ratio is 13, your average collection period is 365 / 13, or 28 days.
In general, the lower the collection period, the better. A low collection period value shows you that your business is collecting the cash it is owed faster. Higher collection periods may be a sign that your business’s credit policies are too lax and may need to be looked into further. A collection period that trends higher over time can signal potential financial disaster for a company, depending upon how much of its sales are based on credit.
The collection period is a great way to see how fast your credit sales covert to cash for your business. It’s rather easy to calculate and is probably something you should start keeping an eye on if your business accepts credit sales.