Average Collection Period
If you are wondering why your business is always short on cash, you might take a look at your average collection period. This is the average number of days between the date that you make a sale on credit and the date you actually get the money in your hands.
The lower the average the better, although you might be annoying your customers if you offer less than 30 days’ payment terms. So it’s always a good idea to compare your average with that of the competition.
One way to calculate your average collection period is to take the average accounts receivable balance for a year and divide that by your credit sales per year. To get the average accounts receivable balance take the AR number at the beginning of the year, add the AR balance at the end of the year and divide by 2. So if your balance is $40,000 at the beginning of the year and $20,000 at the end of the year, add them together and divide by 2 to get $30,000. Then divide that by your total net sales of $300,000 per year and multiply by 365 days to the average collection period of 36.5 days. Not too bad.
Some companies offer a 1%-2% discount for paying on time, while others get on the phone and make friendly collection calls so that they are able to pay their own bills.
Related or Semi-related Video
Finance: What is Days Sales Outstanding?30 Views
finance a la shmoop- what is days sales outstanding? okay so this isn't a
congratulatory missive, like hey you have a lot of sales today [men in suits smile]
outstanding! no it's nothing like. that day sales outstanding or dsos is a
balance sheet computation that puts in perspective how well or rather how
quickly you are collecting the bills you are owed for stuff you have sold. like
let's say your company pulp friction is selling paper pulp to the newspaper [paper truck]
industry. gradually week after week month after month quarter after quarter your
DSOs are creeping upward from the thirty eight days to now fifty three days in
the course of a few years. well what's going on here
well if the newspaper industry were financially healthy it would be [doctor examines office building]
reasonable that they would want to pay their bills on time, but clearly there is
a trend here. another year goes by and DSOs are now at sixty four days. this is
a problem people the industry is paying for the pulpit consumes to print on
paper at a slower rate than they did before. well why well the newspaper [chart shown]
industry is slowly going broke and they're trying to conserve as much cash
as they can, by leaning on their vendors to essentially finance them so that they
you know die more slowly. key takeaway DSOs are a relative number that is in a [equation]
vacuum, if you just look at one number as a representation of DSOs it doesn't
really mean anything. dsos have to be taken in context of the
history of the company itself and in context of whatever the industry average
is. like maybe the average DSO of a pulp maker is highly seasonal, and each year at [man smiles with sunshine and rain]
ebbs and flows with the weather. or maybe your particular pulp company was way
better than the norms and it's just normalizing as DSOs creep back up to the
industry standard of 64 days. context. alright so the calculation. how do you
calculate DSO? well it's this just accounts receivable divided by sales [equation]
made on credit. and if you're inside of a large corporation you can assume that
all sales are made on credit. it's not like a McDonald's Store where a USA
Today or The Wall Street Journal walks in hands [ drive through window]
warehouser the pulp company 14 million dollars in cash for 7,000 tons of pulp.
think about the equation. its volatile. and it can turn into a quote good
unquote number quickly by having your pulp [man eats dinner]
selling business turned sour. like nobody buys from you for a long time and
everyone pays their bill .well all of a sudden you have a DSO number of like [dump truck knocks man over]
five, because nobody owes you money in the form of your account receivable. not
a good situation either again DSOs need context. a huge DSO number can be just
fine as well all of the sudden China Russia and all [world map]
of Latin America buy your pulp. you suddenly have a billion dollars in
accounts receivable and it'll take you months and months and months to fulfill
those orders. so your dsos then balloon up and look
bad, well most companies would kill to have this quote bad unquote DSO number. [man is mugged]
so that's it DSOs are just a relative index of how well you are collecting
your bills. receivables over sales that's it. outstanding work [equations]
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