Average Collection Period Ratio and QuickBooks 2013 - dummies

Average Collection Period Ratio and QuickBooks 2013

By Stephen L. Nelson

QuickBooks 2013 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.

A Simple Balance Sheet
Cash $25,000
Inventory 25,000
Current assets $50,000
Fixed assets (net) 270,000
Total assets $320,000
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.

A Simple Income Statement
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:


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.