Average collection period is the amount of time required for a business to receive payments from clients. It can be thought of as the time that elapses between the date that a credit sale is made and the date that the full amount is collected from the customer. It is usually calculated in terms of accounts receivable (AR). A shorter average collection period is viewed more favorably than a longer one, as this signals that a property collects payments faster.
What is Average Collection Period For?
Average collection period is calculated so that a hotel or resort property can be sure they have enough cash on hand to meet its financial obligations. It is also used to calculate the effectiveness of a property’s credit granting policy and collection efforts.
Benefits of Average Collection Period
Managing the average collection period is an essential tool for hotels to manage efficient operations. It allows revenue managers to evaluate credit terms and determine whether they are too strict or too lenient.
Limitations of Average Collection Period
While most hotels or resorts will seek to shorten their average collection period, there is a downside to this strategy. A very short average collection period can signal that the property’s credit terms are too strict. In some cases, this can cause guests to seek out competitor’s with more lenient collection terms.
How is Average Collection Period Calculated
Average collection period is calculated by dividing the number of days in a calendar year (365) by the accounts receivable turnover ratio. This ratio is determined by dividing credit sales for the year by the average amount of accounts receivable for that same year.
Example of Average Collection Period Calculation
Average Collection Period = Average Accounts Receivable / (Annual Credit Sales / 365)
Average Annual Accounts Receivable = $50,000
Total Annual Credit Sales = $500,000
Number of Days in Year = 365
Average Collection Period = $50,000 / ($500,000 / 365) = 36.5
This indicates that an average of 36.5 days elapsed between when credit sales were made and when the full amount is collected from customers.