Moreover, it is a good metric to measure the liquidity of a company and analyze the credit policy adopted.

The average collection period is an important metric for businesses to monitor. It measures the efficiency of their accounts receivables management system and indicates their liquidity. A company’s average collection period is computed by dividing the average accounts receivable balance by the total net credit sales and multiplying that figure by the number of days in the period. The resulting value indicates the number of days it takes the business to collect payments.

The shorter the average collection period, the better. A low average collection period generally implies that a company is managing its AR efficiently by collecting payments on time. Quick collection of receivables helps to maintain a healthy cash flow, allowing companies to meet their financial obligations in a timely manner. On the other hand, a high average collection period may suggest the company has trouble collecting from customers and/or has an ineffective credit policy.

In addition to providing an indication of payment collection reliability and liquidity, the average collection period is also used to predict future cash flows. Analysing the company’s collection trend over time can provide insight into whether there have been any changes in payment behavior that could impact the future cash flow of the business. This information can then be used to adjust the credit terms accordingly.

Overall, the average collection period is an important tool for businesses to measure their accounts receivable management system’s effectiveness and ensure they have enough cash on hand to meet their financial obligations. Keeping a track of the average collection period helps businesses them to make informed decisions when setting credit terms and creating cash flow projections.