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The average collection period is an important figure your business needs to know if you’re to stay on top of payments. Late payments are inevitable, but how do you define what ‘late’ actually is? That’s where the average collection period comes in. Here’s how to calculate average collection period figures for your business.
What is the average collection period?
While you may state on the invoice itself that you expect them to be paid in a certain timeframe – say, three weeks – the reality might be vastly different, for better or worse.
Why is the average collection period important?
It’s easy to think that the only thing that matters about invoices is that they get paid, but actually, the time required for each invoice to be fulfilled is also crucial.
The average collection period should be closely monitored so you know how your finances look, and how this impacts your ability to pay for bills and other liabilities. There’s a big difference between knowing you’re due to be paid $10,000 and safely having it in your business bank account.
How to calculate average collection period
Knowing how to find the average collection period is something your finance team should know by heart, but it’s also good for you, as a business owner, to keep an eye on this metric. Luckily, it’s easy to find this figure with online tools like an average collection period calculator, or a quick calculation with the following average collection period formula:
So, if your company has a receivable balance of $20,000 for the year, and your total net sales were $200,000, you will apply the average collection period formula like so:
$20,000 / $200,000 = $0.1
$0.1 x 365 = 36.5
That means it takes, on average, around 37 days for invoices to be paid.
What is a good average collection period?
So, now you know how to calculate the average collection period, you need to understand what the resulting figure means. Most companies expect invoices to be paid in around 30 days, so anything around this figure should be considered relatively normal. Any higher – i.e., heading into 40 or more – and you might want to start considering the cause.
In some cases, this may be out of your control, such as a downturn in the economy which means everyone is struggling to find the funds needed to pay their bills. Alternatively, the issue may be entirely within your control, such as a finance team that isn’t prioritising incoming payments, whether that means issuing an invoice or chasing them up.
If your average collection period calculator result is showing a very low rate, this is generally a positive thing. However, it may also suggest that your credit policy is too strict. For example, if you impose late payment penalties on a relatively short period, say, 20 days, then you run the risk of scaring clients off. You should take competitors into account when setting your credit terms, as a customer will almost always go with the more flexible vendor when it comes to payment terms.
Remember, your resulting figure is as temperamental as the clients you serve, so it’s never a bad time to pull out the average collection period calculator and get an update on your status.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.