What Is Receivables Collection?
Definition of the Receivable Collection Period
- The receivable collection period is a period when a firm receives the amount owed by their customers (Account receivable).
- Firms need to know this because they have to make sure they have enough in hand for their current obligations.
- Because of the time value of money, firms aim to keep this period as short as possible without losing other benefits.
- Depending on the business management style, there is no specific number of days that are the best. However, most firms collect them within thirty days.
- If it takes a firm longer than they expect, they should implement a more efficient method of collection.
What is the Formula for the Receivable Collection Period?
- The average collection period can be calculated with two formulas.
- The first one is to multiply days in period with average account receivables and divide them average credit sales per day.
Receivable collection period = (Days in period x Average account receivables) / Average credit sales per day
- The second way to calculate it is to divide the number of days in period by account receivable turnover ratio.
Receivable collection period = Days in period / Account receivable turnover ratio
- The account receivable turnover ratio is calculated by dividing net credit sales by average accounts receivable.
Accounts receivable turnover = Net credit sales / Average accounts receivable
Receivable Collection Period in Practice
- Assume that Nancy’s flowers have an average account receivable of $60,000 for the year and average credit sales per day on $900,000.
- The average collection period would be (365 x $60,000)/ $900,000 = 24.33 OR
- Accounts receivable turnover = $900,000/$60,000 = 15, Receivable collection period = 365/15 = 24.33
- In conclusion, Nancy’s flowers take around 24 to 25 days to collect their accounts receivable.