Average Collection Period

The Average Collection Period measures the time it takes for a business to receive payments owned. It has proven to be a valuable recourse when determining the strength of a company. Or at least how much cash flow they can get from their sales.

The idea behind this indicator is that a company may make a sale, but they do not always collect their money up front. Some companies may wait to collect payments from their customers. If they do we would want to know how long it usually takes for the company to actually see their profits. This is the idea behind the ratio.

The formula for this ratio looks like this

ACP = (Days)*(Average Accounts Receivable) / (Credit Sales)

So if a company made 1 million dollars in sales last year and 600,000 in accounts recieveable during the same period the equation would look like this ACP= (365)*(600,000)/(1,000,000). That would give them an average collection period of 219 days.

This means it takes the company an average of 219 days to collect on their sales. The lower this number is the better. Companies need to not only make sales but they need to collect the money from the sales in order to pay expenses and grow.

One thing to consider is that the longer it takes for a company to collect their money the less likely it is that the company will actually see the money. It seems to be human nature that the longer it takes for us to pay something off the less likely it is that we will pay it off.

This is why it is normally better to see a shorter collection period if you are investing into the company. But this is not true for all businesses. Keep in mind that there are plenty of companies such as credit cards and banks where you will naturally get a large period.

That is why it is best to use your own judgment with this ratio.