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How long does it take for your customers to pay you after you send an invoice? If it exceeds 45 days, you may be experiencing cash flow problems without knowing it. A survey found that 93% of companies have late payments, which directly affects their capacity to pay staff, reinvest, and continue operating.
Getting paid late isn't just frustrating; it can be the difference between a thriving business and a struggling one. That's where the average collection period (ACP) comes in. This straightforward but effective metric lets you evaluate how well your business collects payments. In this guide, we'll break down how to calculate ACP, look at actual cases, and offer practical strategies to enhance your collection cycle. Let's get started!
The average collection period, or ACP, is the number of days a business takes to collect money from its credit sales. Businesses may better grasp their cash flow and financial health with the help of this crucial statistic.
A shorter ACP means a business is collecting payments quickly, improving liquidity. Conversely, a longer ACP denotes delayed collections, which may result in cash shortages or make it more challenging to pay operating costs. Although each business has a different optimal ACP, a company can maintain a healthy cash cycle by routinely checking it.
A company with $100,000 in credit sales and $10,000 in accounts receivable has an ACP of:
This means, on average, it takes 36.5 days to collect payments.
Now that you know what ACP is, let’s see how to calculate it step by step.
Understanding your average collection period (ACP) helps you gauge how efficiently your business collects outstanding invoices. A lower ACP means faster cash inflows, while a higher ACP could indicate collection issues. Fortunately, if you have the correct data, determining ACP is easy.
The above bar chart shows the relationship between Accounts Receivable and Net Credit Sales, with the Average Collection Period (ACP) formula overlaid.
The formula for ACP is:
Example Calculation:
If a business has $50,000 in accounts receivable and $500,000 in net credit sales, the ACP would be:
This means, on average, it takes 36.5 days to collect payments.
Pro Tip: Businesses that track ACP monthly should use 30 or 31 days instead of 365 to get an accurate short-term view.
Let's now use real-world examples to apply this formula to other sectors.
Now that you understand the formula let's examine how companies in various sectors use the average collection period (ACP). Businesses can assess the effectiveness of their receivables management and make well-informed decisions to enhance their cash flow by computing ACP. Here are some actual instances of ACP computations in several business settings.
Example 1: Retail Business
A clothing store generates $200,000 in net credit sales annually and has $20,000 in accounts receivable.
A 36.5-day ACP is reasonable, but reducing it further could improve cash flow.
Example 2: Manufacturing Company
A manufacturer selling industrial equipment reports $2,000,000 in net credit sales and $500,000 in AR.
A 91-day ACP might be acceptable in this industry, where B2B transactions often involve long credit terms.
Example 3: Service-Based Business
A financial solutions provider has $1,000,000 in net credit sales and $120,000 in accounts receivable. Applying the ACP formula:
With an ACP of 43.8 days, this service-based business takes an average of 44 days to collect client payments. Financial services companies usually concentrate on lowering ACP through tactics like automated invoicing and early payment discounts to speed up cash inflows because they frequently depend on quicker collections to preserve liquidity.
After seeing how ACP works in different sectors, let's examine the good average period for other sectors.
The ideal average collection period (ACP) varies depending on the industry and business model. Businesses can determine whether their ACP is within a healthy range by knowing basic ranges, even though there isn't a single standard that works for everyone. Here's a quick look at industry averages:
The above bar chart compares the ideal Average Collection Period (ACP) ranges for different industries.
While a very low ACP can imply overly stringent credit terms that might turn off potential clients, a high ACP might indicate ineffective collections or problems with receivables.
Let's discuss practical ways to lower your ACP if it is excessively high.
You may use several tactics to shorten your average collection period (ACP) and enhance cash flow if it is longer than you would want. You can drastically reduce your ACP and accelerate the flow of funds by emphasizing speedier payments, optimizing procedures, and strengthening regulations.
Here are a few proven methods to lower your ACP and speed up collections:
Promoting early payments is one of the best strategies to extend your collecting period. By providing a 1-2% discount to clients who pay within 10 to 15 days, you may encourage them to pay their bills on time and lower your ACP.
Pro Tip: To create a sense of urgency, make sure the terms of the discount are clear on invoices and consider making it a recurrent offer.
You may reduce human mistakes and save time by automating your billing and follow-up procedures. With tools like Xero, FreshBooks, or QuickBooks, you can automate invoicing and send out reminders when deadlines draw near.
Pro Tip: You can drastically cut down on late payments by setting up automated reminders to be sent out 7, 14, and 21 days after the invoice date.
Screening potential clients before extending credit can help prevent overdue payments in the first place. You can lower the chance of bad debts by checking payment history, evaluating credit scores, and doing background checks.
Pro Tip: Consider imposing upfront deposits or shorter payment terms for clients with a history of late payments. By doing this, you establish clear expectations and reduce risk.
Instead of offering Net 60 or Net 90 payment terms, consider reducing it to Net 30 or Net 15. You can prevent cash flow delays by asking for payments immediately.
Pro Tip: Try to keep the terms as brief as possible without offending most customers, but provide flexible terms to those who require them.
When accounts become overdue, partnering with a professional debt collection agency can help recover payments efficiently. These agencies have the experience and legal expertise to collect unpaid debts while guaranteeing adherence to all applicable laws. To manage challenging accounts, they adhere to stringent protocols safeguarding your interests and rapport with the client.
For instance, when clients' invoices are much past due, South East Client Services (SECS), a financial solutions provider, collaborates with reputable debt recovery organizations. By doing this, they can maintain their cash flow and concentrate on their main company functions.
Pro Tip: Only consider third-party collection agencies after exhausting all internal efforts to collect the debt. This helps maintain good customer relationships and ensures you've made every effort to settle the matter directly before escalating it.
Even with these strategies in place, companies frequently miscalculate ACP. Let's examine some typical errors and how to avoid them.
Making mistakes while figuring out your average collection period (ACP) might result in poor cash flow management and deceptive financial judgments. By being aware of and avoiding these typical errors, you can ensure your ACP stays correct and makes better business decisions. The most common mistakes and methods to prevent them are as follows:
Now that we've explored common ACP mistakes let's wrap up by discussing the key takeaways and how understanding ACP can help your business thrive.
The average collection period (ACP) is a critical metric for managing your business’s cash flow. You can take practical steps to enhance collections and decrease payment delays by knowing how to compute ACP and what defines a good or bad period. You may maintain a healthy and effective cash flow by enforcing stricter credit regulations, automating invoicing, and providing early payment discounts.
To assist businesses maximize their collection periods, SECS provides customized systems that include automated invoicing, smart credit policies, and skilled receivables management. Companies may increase liquidity, guarantee on-time payments, and reinvest in their services for sustained growth by partnering with SECS.
Are you ready to increase cash flow and optimize your collection process? Contact SECS today to explore how their solutions can support your business's financial health!
