Receivables Turnover & Average Collection Period

Receivables Turnover & Average Collection Period

Formulas

$$\text{Receivables turnover} = \frac{\text{Net sales (preferably credit sales)}}{\text{Average receivables}}$$

$$\text{Average collection period} = \frac{365}{\text{Receivables turnover}}$$

Explanation

• Receivables turnover: how many times per year receivables are turned into cash.
• Average collection period: how many days on average it takes to collect from customers.
• Measures the effectiveness of credit policy and collection.

Satisfactory level

• Compare average collection period with credit terms (e.g. 30 days, 60 days).
  • If average is much longer than credit term → problem with collection.

Industry norm

• Industries with installment or long-term credit naturally have longer collection periods.
• Cash-based retail has very high turnover and very short collection period.

Example

• Net credit sales = RM1,200,000
• Receivables at beginning = RM100,000; end = RM140,000
• Average receivables = (100,000 + 140,000) ÷ 2 = RM120,000

$$\text{Receivables turnover} = \frac{1,200,000}{120,000} = 10 \text{ times}$$
$$\text{Average collection period} = \frac{365}{10} = 36.5 \text{ days}$$

If credit term is 30 days, 36.5 days is slightly slow but not terrible.