How to Calculate Accounts Receivable Collection Period
Calculating the accounts receivable collection period is a crucial step in managing the cash flow of a business. The accounts receivable collection period (ARCP) measures the average amount of time it takes for a business to collect payment from its customers. In this article, we'll explain the ARCP formula and how you can use it to monitor your cash flow and make informed business decisions.
Understanding the Accounts Receivable Collection Period Formula
The accounts receivable collection period formula is calculated by dividing the average accounts receivable balance by the average daily credit sales. The resulting number represents the number of days it takes for a business to collect payment from its customers. The formula is as follows:
ARCP = Average Accounts Receivable Balance / Average Daily Credit Sales
Importance of Monitoring Accounts Receivable Collection Period
By regularly monitoring the ARCP, a business can ensure that its cash flow remains positive and that it can meet its financial obligations on time. A high ARCP indicates that it takes longer for a business to collect payment from its customers, which can negatively impact cash flow and cause financial difficulties. On the other hand, a low ARCP indicates that a business is collecting payment from its customers quickly, which is a positive sign for its financial stability.
Factors Affecting Accounts Receivable Collection Period
Several factors can affect the accounts receivable collection period, including:
- Customer payment habits: If a business has customers who regularly pay late, it can increase the ARCP.
- Credit terms: The length of credit offered to customers can affect the ARCP. A longer credit period will increase the ARCP, while a shorter credit period will decrease it.
- Sales volume: The higher the sales volume, the lower the ARCP is likely to be.
- Economic conditions: Economic conditions can impact the ARCP, with a weak economy leading to longer collection periods.
Using the Accounts Receivable Collection Period to Make Business Decisions
By regularly monitoring the ARCP, a business can make informed decisions to improve its financial performance. If the ARCP is high, a business can take steps to shorten the collection period, such as offering shorter credit terms or following up with customers who regularly pay late. On the other hand, if the ARCP is low, a business can consider offering longer credit terms to attract more customers and increase sales.
To calculate the average collection period, use either of the following formulas:
- (A/R balance ÷ total net sales) x 365 = average collection periodExample: ($50,000 ÷ $800,000) x 365 = 22.8 days average collection period
- 365 ÷ (net credit sales ÷ average A/R balance) = average collection periodExample: 365 ÷ ($800,000 ÷ $50,000) = 22.8 days average collection period
Note: Both formulas give the same result if you have accurate data.
In conclusion, the accounts receivable collection period is an important metric for monitoring the cash flow of a business. By regularly calculating the ARCP and taking steps to improve it, a business can ensure its financial stability and make informed business decisions.