Average Collection Period

The Average Collection Period is a key performance indicator in the category of Financial KPIs. It measures the average number of days that an organization takes to collect payment from its customers after a sale has been made on credit. This indicator is instrumental in evaluating the effectiveness of a company's accounts receivable management and its credit policy.

A shorter average collection period implies that the company collects its receivables quickly, which could be an indicator of effective credit policies and collection efforts. Conversely, a longer average collection period may indicate potential issues in receivable management which can impact the company’s cash flows.

Calculation

The Average Collection Period can be calculated using the following formula:

Average Collection Period = (Accounts Receivable / Annual Credit Sales) x 365

• Accounts Receivable: This is the amount of money owed by customers to the company for goods or services bought on credit.
• Annual Credit Sales: These are the total sales made on credit during the year.

Note: The '365' in the formula represents the number of days in a year, which standardizes the calculation.

The resulting number is expressed in days and represents the average time it takes the company to convert its credit sales into cash.

Keep in mind that the ideal average collection period varies from industry to industry. For some businesses, a shorter collection period might be ideal, while others may operate optimally with a longer collection period due to the nature of the industry or the credit terms they offer.