The term average receivable collection period refers to a metric that allows an investor-analyst, or a management team, to understand the average number of days sales are outstanding. The calculated rate, expressed in days, takes the average accounts receivable and divides it by the amount of sales revenue occurring in one day.
Average Receivable Collection Period = Average Accounts Receivable / (Annual Revenue / 365)
Liquidity measures allow the investor-analyst to understand the company's long term viability in terms of fiscal health. This is usually assessed by examining balance sheet items such as accounts receivable, use of inventory, accounts payable, and short-term liabilities. One of the ways to understand how quickly customers are paying for items purchased on credit is by examining the company's average receivable collection period.
Also known as days sales outstanding (DSO), calculating the average receivables collection period allows the investor-analyst, or a company's management team, to understand the effectiveness of a company's collection practices as well as their credit policies. The metric takes average accounts receivable and divides it by average daily sales to determine the average number of days it takes a customer to repay sales made on credit.
Company ABC's CFO would like to examine the company's credit policy. She's concerned that accounts receivable is growing relative to sales revenues and would like to understand how quickly sales on credit are being paid by customers. Presently, the company allows customers to repay sales on credit in 30 days, so she's hoping the value is no higher than 35 days. Her team of analysts examined data for the last twelve months and found the starting balance of accounts receivable to be $14,756,000 and the ending balance $16,129,000. Total sales revenue in the same timeframe was found to be $154,425,000. Using this information CFO's analyst team calculated average receivables collection period as:
= (($14,756,000 + $16,129,000) / 2) / ($154,425,000 / 365)
= ($30,885,000 / 2) / $423,082
= $15,442,500 / $423,083, or 36.5 days
Since Company ABC's days sales outstanding is higher than 35, the CFO ordered her sales and finance teams to dive deeper into the company's credit policy and make a recommendation to lower this value to senior management in the next two weeks.