Average Collection Period

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DEFINITION of 'Average Collection Period'

The approximate amount of time that it takes for a business to receive payments owed, in terms of receivables, from its customers and clients.

Calculated as:

 

Average Collection Period

Where:
Days = Total amount of days in period
AR = Average amount of accounts receivables
Credit Sales = Total amount of net credit sales during period

BREAKING DOWN 'Average Collection Period'

For example, suppose that a widget making company, XYZ Corp, has total credit sales of $100,000 during a year (assume 365 days) and has an average amount of accounts receivables is $50,000. Its average collection period is 182.5 days.

Due to the size of transactions, most businesses allow customers to purchase goods or services via credit, but one of the problems with extending credit is not knowing when the customer will make cash payments. Therefore, possessing a lower average collection period is seen as optimal, because this means that it does not take a company very long to turn its receivables into cash. Ultimately, every business needs cash to pay off its own expenses (such as operating and administrative expenses).

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