collection ratio

Fin

the average number of days it takes a firm to convert its accounts receivable into cash.

EXAMPLE

Ideally, this period should be decreasing or constant. A low figure means the company collects its outstanding receivables quickly. Collection ratios are usually reviewed quarterly or yearly.

     Calculating the collection ratio requires three figures: total accounts receivable, total credit sales for the period analyzed, and the number of days in the period (annual, 365; six months, 182; quarter, 91). The formula is:

accounts receivable/total credit sales for the period × number of days in the period

For example: if total receivables are $4,400,000, total credit sales in a quarter are $9,000,000, and number of days is 91, then:

4,500,000/9,000,000 × 91 = 45.5

Thus, it takes an average 45.5 days to collect receivables.

     Properly evaluating a collection ratio requires a standard for comparison. A traditional rule of thumb is that it should not exceed a third to a half of selling terms. For instance, if terms are 30 days, an acceptable collection ratio would be 40 to 45 days.

     Companies use collection ratio information with an accounts receivable aging report. This lists four categories of receivables: 0–30 days, 30–60 days, 60–90 days, and over 90 days. The report also shows the percentage of total accounts receivable that each group represents, allowing for an analysis of delinquencies and potential bad debts.

Also known as days’ sales outstanding