Definition: The average collection period indicates the average number of days elapsed between a credit sale and the date the company receives the payment from the credit sale.
What Does Average Collection Period Mean?
What is the definition of average collection period? The ACP is a strong indication of a firm’s liquidity over the accounts receivable, which is the money that customers owe to the company, as well as of the company’s credit policies. A short average collection period suggests a tight credit policy and effective management of accounts receivable, which both allow the firm to meet its short-term obligations.
Conversely, a long ACP indicates that the company should tighten its credit policy and improve the management of accounts receivable to be able to meet its short-term obligations. To calculate the average collection period formula, we simply divide accounts receivable by credit sales times 365 days.
Let’s look at an example.
Example
Company ABC is a retail company that operates in the home appliance industry. The company has a tight credit policy because it plans to pay off its short debt by the end of the fiscal year. Annabel, the company’s accountant, wants to calculate the average period and determine if there should be any adjustments in the company’s credit policies.
The company’s accounts receivable is $10,185 for the last quarter. For this amount, Annabel calculates that the credit sales are $105,452. Therefore:
ACP (Q3 2015) = $10,185 / $105,452 x 365 = 35.2 days
This means that customers pay their credit to the company every 35 days on average.
Annabel calculates the average collection for the same quarter last year as a basis for comparison. Therefore:
ACP (Q3 2014) = $13,254 / $110,986 x 365 = 43.6 days
The collection period has dropped by 8 days YoY, and it has improved. However, it remains high. The company needs to adjust its credit policies to lower the collection period down to a week and be able to meet its short-term obligations.
Summary Definition
Define Average Collection Period: ACP means the time it takes to receive money from customers who purchase goods and services on account.
