Using the Average Collection Period

April 13, 2006

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The average collection period can be used to determine the effect of different collection periods on your business's cash flow. This is best illustrated by the following chart.

Sales Per Day
Average Collection Period	$200	$300	$400	$500	$600
Investment in Accounts Receivable
30	$ 6,000	$ 9,000	$12,000	$15,000	$18,000
40	8,000	12,000	16,000	20,000	24,000
50	10,000	15,000	20,000	25,000	30,000
60	12,000	18,000	24,000	30,000	36,000

The above chart illustrates the effect that a change in the average collection might have on the investment in accounts receivable for your business. Remember, accounts receivable represent money that cannot be used for other cash outflow purposes. For example, assume that your average sales amount per day is $300, and that your average collection period is 40 days. Now assume that you were able to reduce your average collection period from 40 days to 30 days. From the illustration above, you can see that the reduction in the average collection period reduces the investment in accounts receivable from $12,000 to $9,000. This reduction generated an additional $3,000 in your cash flow!