How to calculate Average Collection period? And why it is an important part of any business?

The average collection period.

Formula is the number of days in a period divided by the receivables turnover.

NOTE:

In order to understand the concept of the average collection period.

One must first look at the accounts receivables turnover.

Sales revenue is the amount a company earns in sales or services from its primary operations.

Sales revenue can be found on a company's income statement under sales or operating revenue.

Accounts receivables can be found on a company's balance sheet.

The average collection period formula can be rewritten as.

Example of the Receivables Turnover

Suppose that the income statement from a company shows operating revenues of SAR2,000,000 (2million).

The same company has accounts receivables of SAR160,000 the current financial period and SAR180,000 the prior financial period.

The average accounts receivables is SAR170,000

Impotance of the Receivables Turnover

The receivables turnover ratio is used to calculate how well a company is managing their receivables.

A company needs to collect revenues in order to cover expenses and/or reinvest.

A lack of collecting sooner is potentially a loss of future earnings from reinvesting.

However, customers may look to competitors if the collection is overbearing.

We can calculate the average collection period for an individual customer with his paid invoices for particular period.Here we use weighed average method to arrive the average period.

To demonstrate, let's take the value of sample invoices in USD and credit days no of taken by customer to pay.

Invoices Amt:

Credit days:

To average these invoices, do a weighted average using the number of credit days of each Amt as the weight. To calculate a weighted average:

1. Multiply each value by its weight. (Ans:10*2=20,8*=16,5*1=5,4*10=40,3*8=24,2*7=14,1*68=68,and0*2=0)

2. Add up the products of value times weight to get the total value. (Ans: Sum0,16,5,40,24,14,68, and0 =187)

3. Add the weight themselves to get the total weight. (Ans: Sum2,2,1,10,8,7,68,2 =100)

4. Divide the total value by the total weight. (Ans:187/100 =1.87 = average collection days )