The Average Collection Period: A Crucial Metric for Small Businesses
In the dynamic world of small businesses, cash flow is essential. A healthy cash flow ensures that you can meet your financial obligations, invest in growth, and keep your operations running smoothly. The Average Collection Period (ACP), a key financial metric, plays a pivotal role in maintaining a steady cash flow.
What is the Average Collection Period?
The Average Collection Period (ACP) is the average number of days it takes a company to collect payment from customers on credit sales. It represents the time it takes for your accounts receivable (money owed to you by customers) to convert into cash.
How to Calculate Your Average Collection Period?
Calculating your ACP is a straightforward process:
Determine your annual net credit sales: This is the total amount of credit sales you've made in a year, excluding any returns or discounts.
Calculate your average accounts receivable: This is the average balance of your accounts receivable throughout the year. To find this, add the beginning and ending balances of your accounts receivable and divide by two.
Divide your annual net credit sales by your average accounts receivable. This is your accounts receivable turnover.
Use 365 (days) and divide by your accounts receivable turnover result. This equals your average collection period.
For example, if your annual net credit sales are $100,000 and your average accounts receivables are $20,000, your average accounts receivable turnover is 5. 365 divided by 5, which gives you an ACP of 73. This means it takes an average of 73 days for your customers to pay you for the products or services you've provided. According to a survey by HighRadius, the average ACP for small businesses in the US was 47 days in 2020.
Why is the Average Collection Period Important?
The ACP is a crucial metric for small businesses for several reasons:
Cash Flow Management: A shorter ACP indicates faster collection of receivables, which translates to better cash flow. This allows you to cover expenses, invest in growth, and maintain financial stability.
Performance Indicator: The ACP reflects the efficiency of your credit and collections processes. A long ACP suggests potential issues in creditworthiness assessment, invoicing accuracy, or collections strategies.
How to Improve Your Average Collection Period?
Here are some strategies to improve your ACP:
Early Payment Discounts: Offer discounts for customers who pay their invoices early. This incentivizes prompt payments and reduces your ACP.
Shorter Credit Terms: Evaluate your credit terms and consider shortening them, especially for high-risk customers. This can expedite collections and improve cash flow.
Credit Policy: Implement a clear and well-defined credit policy that outlines creditworthiness criteria, credit limits, and payment terms. This ensures consistent application of credit standards.
Efficient Invoicing: Streamline your invoicing process to ensure timely and accurate invoices are sent to customers. This reduces the likelihood of payment delays due to billing errors.
Technology Integration: Utilize technology solutions to automate invoicing, payment reminders, and collections follow-ups. This frees up your time to focus on other aspects of your business.
By understanding and managing your ACP, you can take control of your cash flow, improve your financial health, and position your small business for long-term success.
