Question

Class, what is the formula for Average Collection Period? Why do you use it and how does it work? Please provide an example.

Answer 1

Average Collection period can be defined as average period needed to convert account receivables into cash.

Average collection period = 365/ Receivable Turnover Ratio , where receivable turnover = Sales/ Account receivables.

Collection period is an efficiency measurement parameter which can be compared with industry peers and the benchmark for the right assessment for decision making. If there is large collection period, then it means that a firm is not efficient in collecting cash from its customers.

For example, a firm having Sales of $ 100 with receivables of 50 will have the turnover of 100/50 =2 and average collection period of = 360/2 = 180 days.