Average Collection Period Ratio and QuickBooks 2012
QuickBooks 2012 and several different activity ratios can help manage your assets. The average collection period ratio shows how long it takes for a firm to collect on its receivables. You can think about this ratio as a measure of the quality of a firm’s credit and collection procedures.
In other words, this ratio shows how smart a firm is at deciding to whom to extend credit. This ratio also shows how effective a firm is in collecting from customers.
The average collection period ratio formula looks like this:
average accounts receivable/average credit sales per day
The balance sheet shown doesn’t show an average accounts receivable balance.
| Assets | |
| Cash | $25,000 |
| Inventory | 25,000 |
| Current assets | $50,000 |
| Fixed assets (net) | 270,000 |
| Total assets | $320,000 |
| Liabilities | |
| Accounts payable | $20,000 |
| Loan payable | 100,000 |
| Owner’s equity | |
| S. Nelson, capital | 200,000 |
| Total liabilities and owner’s equity | $320,000 |
The income statement shown also doesn’t break out sales into credit and cash components.
| Sales revenue | $150,000 |
| Less: Cost of goods sold | 30,000 |
| Gross margin | $120,000 |
| Rent | 5,000 |
| Wages | 50,000 |
| Supplies | 5,000 |
| Total operating expenses | 60,000 |
| Operating income | 60,000 |
| Interest expense | (10,000) |
| Net income | $50,000 |
Suppose that in the business you run, the average accounts receivable is $60,000. Further suppose that your average credit daily sales equal $1,000. Using the formula just given, you can calculate the average collection period as follows:
$60,000/$1,000
This formula returns the value 60. In this case, your business has 60 days of sales in accounts receivable.
The guideline about the average collection period is that it should tie to your payment terms. If your average number of days of credit sales in accounts receivable equals 60, for example, your payment terms should probably be something like net 60 days (which means customers are supposed to pay you in 60 days or less).
Your average collection period, in other words, should show that most of your customers are paying on time. Remember that some of your customers will pay early, and obviously, some of your customers will pay a bit late. You hope that, on average, customers pay on time.
