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Average Receivable Collection Period

Moneyzine Editor
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Moneyzine Editor
2 mins
November 6th, 2024
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Average Receivable Collection Period

Definition

The term average receivable collection period refers to a metric that allows an investor-analyst, or a management team, to understand the average number of days sales are outstanding. The calculated rate, expressed in days, takes the average accounts receivable and divides it by the amount of sales revenue occurring in one day.

Calculation

Average Receivable Collection Period = Average Accounts Receivable / (Annual Revenue / 365)

Where:

  • Average accounts receivable is an average over the last 12 months or prior year. The important point is the timeframe should be the same as that used for annual revenue.

  • Note that the metric is in calendar days, not business days.

Explanation

Liquidity measures allow the investor-analyst to understand the company's long term viability in terms of fiscal health. This is usually assessed by examining balance sheet items such as accounts receivable, use of inventory, accounts payable, and short-term liabilities. One of the ways to understand how quickly customers are paying for items purchased on credit is by examining the company's average receivable collection period.

Also known as days sales outstanding (DSO), calculating the average receivables collection period allows the investor-analyst, or a company's management team, to understand the effectiveness of a company's collection practices as well as their credit policies. The metric takes average accounts receivable and divides it by average daily sales to determine the average number of days it takes a customer to repay sales made on credit.

Example

Company ABC's CFO would like to examine the company's credit policy. She's concerned that accounts receivable is growing relative to sales revenues and would like to understand how quickly sales on credit are being paid by customers. Presently, the company allows customers to repay sales on credit in 30 days, so she's hoping the value is no higher than 35 days. Her team of analysts examined data for the last twelve months and found the starting balance of accounts receivable to be $14,756,000 and the ending balance $16,129,000. Total sales revenue in the same timeframe was found to be $154,425,000. Using this information CFO's analyst team calculated average receivables collection period as:

= (($14,756,000 + $16,129,000) / 2) / ($154,425,000 / 365)= ($30,885,000 / 2) / $423,082= $15,442,500 / $423,083, or 36.5 days

Since Company ABC's days sales outstanding is higher than 35, the CFO ordered her sales and finance teams to dive deeper into the company's credit policy and make a recommendation to lower this value to senior management in the next two weeks.

Related Terms

  • The term sales to inventory ratio refers to a calculation that allows a management team to understand the level of inventory needed on hand to support sales. The metric takes the company's annual cost of goods sold and divides it by yearend inventory.
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  • Accounts Receivable (Receivables)
    Also referred to as "receivables," this is the accounting term used to describe claims the company has against others for goods, services, or money. Accounts receivable are usually non-written promises to pay for goods or services received but not yet paid for by a customer.
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  • The term receivables to sales ratio refers to a metric that allows an investor-analyst to understand how accounts receivable moves with sales revenues over time. The metric simply divides accounts receivable by sales revenue; but tracking this metric over time can provide insights into potential misleading sales information.
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  • Days Delinquent Sales Outstanding
    The term days delinquent sales outstanding refers to a metric that allows an investor-analyst, or a management team, to understand the average number of days sales are outstanding for delinquent customers. The calculated rate, expressed in days, takes the average accounts receivable for those accounts that are delinquent and divides it by the amount of sales revenue associated with those accounts occurring in one day.
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  • Accounts Receivable Forecast
    The term accounts receivable forecast refers to a calculation that allows a management to plan for the investment in accounts receivable at the end of an accounting period. The metric takes the company's days sales outstanding and multiplies it by the average sales per day in the forecast timeframe.
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