The average collection period is the average number of days it takes a business to collect and convert its accounts receivable into cash. It is one of six main calculations used to determine short-term liquidity, that is, the ability of a company to pay its bills (current liabilities) as they come due.
The formula for calculating average collection period is:
Average collection period = (accounts receivable / sales) x number of days in a year
A shorter average collection period (60 days or less) is generally preferable and means a business has higher liquidity.
Average collection period is also used to calculate another liquidity measure, the receivables turnover ratio.
More about the average collection period
Accounts receivable appear on a company’s balance sheet while sales appear on the income statement. Let’s say that ABC Co. has annual sales of $400,000 and accounts receivable of $55,000, its average collection period would be calculated as follows:
($55,000 / $400,000) x 365 days = 50 days
In this example, ABC Co. keeps its accounts receivable up to date.