Accounts receivable period

Definition

The accounts receivable period is the average number of days it takes for a company to collect payment after a sale has been made on credit. This period is crucial for understanding a company’s cash flow and efficiency in managing its credit sales, as a shorter collection period typically indicates better cash flow management and customer payment behavior.

5 Must Know Facts For Your Next Test

1. A typical formula to calculate the accounts receivable period is: $$ ext{Accounts Receivable Period} = rac{ ext{Accounts Receivable}}{ ext{Average Daily Sales}} $$, where average daily sales can be computed from total sales over a specific period.
2. A shorter accounts receivable period can enhance a company's liquidity, as it means cash is being collected more quickly, allowing for reinvestment or covering operating expenses.
3. Companies with longer accounts receivable periods may face cash flow challenges, making it difficult to meet short-term obligations or reinvest in the business.
4. Analyzing the accounts receivable period can help identify potential issues in credit policies or customer payment practices, signaling whether adjustments are necessary.
5. Comparing the accounts receivable period against industry benchmarks helps assess a company's efficiency relative to its competitors.

Review Questions

• How does the accounts receivable period impact a company's cash flow and liquidity?
  • The accounts receivable period significantly affects a company's cash flow because it represents the time taken to convert credit sales into cash. A shorter accounts receivable period means that cash is flowing into the business more quickly, which enhances liquidity and allows for better management of operational expenses and investments. Conversely, a longer period can strain cash flow, making it difficult for companies to cover immediate financial obligations.
• Discuss the implications of having an extended accounts receivable period on a company's credit policy.
  • An extended accounts receivable period may indicate that a company's credit policy is too lenient, leading to delayed payments from customers. This situation can prompt a review of the credit terms offered, such as payment deadlines or interest on late payments. Strengthening the credit policy might involve tightening credit evaluations or reducing credit limits for customers who consistently take longer to pay, ultimately aiming to improve cash collection processes.
• Evaluate how changes in the accounts receivable period might influence strategic decision-making within a business.
  • Changes in the accounts receivable period can provide critical insights for strategic decision-making in a business. If the period decreases significantly, it may indicate improved customer relationships or more effective collections processes, prompting management to invest further in these areas. Alternatively, an increase could signal potential problems that require immediate attention, such as reevaluating customer contracts or enhancing collection efforts. This evaluation directly influences budgeting, forecasting, and resource allocation within the company.

Related terms

Accounts Receivable: Money owed to a company by its customers for goods or services delivered but not yet paid for.

Credit Policy:

The guidelines a company follows to determine how much credit to extend to customers and the terms of that credit.

Cash Conversion Cycle:

The time it takes for a company to convert its investments in inventory and other resources into cash flows from sales.