Average Collection Period Ratio:

Definition:

The Debtors / Receivable Turnover ratio when calculated in terms of days is known as Average Collection Period or Debtors Collection Period Ratio.

The average collection period ratio represents the average number of days for which a firm has to wait before its debtors are converted into cash.

Formula of Average Collection Period:

Following formula is used to calculate average collection period:

 [(Trade Debtors × No. of Working Days) / Net Credit Sales]

Example:

Credit sales $25,000; Return inwards $1,000; Debtors $3,000; Bills Receivables $1,000.

Calculate average collection period.

Calculation:

Average collection period can be calculated as follows:

Average Collection Period = (Trade Debtors × No. of Working Days) / Net Credit Sales

4,000* × 360** / 24,000

= 60 Days

* Debtors and bills receivables are added.
**For calculating this ratio usually the number of working days in a year are assumed to be 360.

Significance of the Ratio:

This ratio measures the quality of debtors. A short collection period implies prompt payment by debtors. It reduces the chances of bad debts. Similarly, a longer collection period implies too liberal and inefficient credit collection performance. It is difficult to provide a standard collection period of debtors.

 

You may also be interested in other relevant articles: Horizontal Analysis or Trend Analysis Trend Percentage Vertical Analysis Limitations of Financial Statement Analysis Accounting Ratios definition, advantages, classifications and limitations Financial Ratio Formulas Profitability ratios: Gross profit ratio Net profit ratio Operating ratio Expense ratio Return on shareholders investment or net worth Return on equity capital Return on capital employed (ROCE) ratio Dividend yield ratio Dividend payout ratio Earnings Per Share Ratio Price earning ratio Liquidity ratios: Current ratio Liquid /Acid test / Quick ratio Activity ratios: Inventory/Stock turnover ratio Debtors/Receivables turnover ratio Average collection period Creditors/Payable turnover ratio Working capital turnover ratio Fixed assets turnover ratio Over and under trading Leverage ratios or long term solvency ratios: Debt equity ratio Proprietary or Equity ratio Ratio of fixed assets to shareholders funds Ratio of current assets to shareholders funds Interest coverage or debt service ratio Capital gearing ratio Over and under capitalization

 

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