Definition:
Average Collection Period is a financial ratio that measures the average number of days it takes a company to collect payments from its customers. It’s a key indicator of a company’s credit management efficiency and its ability to generate cash flow.
Formula:
Average Collection Period = (Average Accounts Receivable / Net Credit Sales) * 365
Why is Average Collection Period important?
- Cash Flow: A shorter average collection period means a company is collecting payments faster, improving its cash flow.
- Credit Risk: A longer average collection period may indicate that a company has a higher risk of bad debts.
- Efficiency: A shorter average collection period suggests efficient credit management practices.
A lower average collection period is generally desirable, as it indicates that the company is collecting payments promptly from its customers. However, it’s important to consider other factors, such as industry standards and the company’s credit policies, when interpreting this ratio.
