One of the crucial sources of cash inflows for a company is its sales. However, some companies offer credit, which can postpone those cash flows. Companies must manage these balances effectively to operate efficiently. They can use accounts receivable days to determine how long it takes them to recover debt from credit sales.
What are Accounts Receivable Days?
Accounts receivable days is a financial metric that measures the average number of days it takes for a company to collect payments from its customers for credit sales. Calculating the accounts receivable to average daily sales allows companies to determine how efficiently they convert credit sales into cash. Analyzing accounts receivable days provides valuable insights into a company’s credit and collection procedures.
A lower accounts receivable days value indicates faster payment collection, which improves cash flow and reduces the risk of bad debts. On the other hand, a higher value suggests slower collection, highlighting potential issues with credit management or customer payment behaviour. By actively managing accounts receivable days, companies can improve their financial health, enhance working capital management, and ensure a steady cash inflow from credit sales.
How to calculate Accounts Receivable Days?
Companies can calculate accounts receivable days by following a simple process. Firstly, they need to determine the total accounts receivable balance, representing the outstanding amount customers owe for credit sales. Secondly, they should calculate the average daily sales by dividing the total credit sales for a specific period by the days in that period.
Finally, companies divide the accounts receivable balance by the average daily sales to obtain the accounts receivable days. After considering the above steps, the formula for accounts receivable days is as follows.
Accounts receivable days = (Accounts receivable / Average daily sales)
Companies can also use the following formula to calculate the accounts receivable days.
Accounts receivable days = Accounts receivable / Total sales x 365 days
Both accounts receivable days formulas provide the same result.
Example
Blue Co. sells its products on credit and wants to determine its accounts receivable days. Here are the relevant figures for the company.
Total accounts receivable balance: $200,000
Total credit sales for the quarter: $450,000
Number of days in the quarter: 90
Before calculating its accounts receivable days, Blue Co. must determine its average daily sales. Based on the data above, this figure comes down to the following.
Average daily sales = Total credit sales / Number of days in the period
Average daily sales = $450,000 / 90 days
Average daily sales = $5,000 per day
Now, Blue Co. can calculate its accounts receivable days as follows.
Accounts receivable days = (Accounts receivable / Average daily sales)
Accounts receivable days = $200,000 / $5,000
Accounts receivable days = 40 days
How to interpret Accounts Receivable Days?
Interpreting accounts receivable days involves assessing a company’s credit management and cash flow. A lower value suggests quicker payment collection, indicating effective credit policies and improved cash flow. It signifies efficient credit management and reduced risk of bad debts. A longer collection period may show lenient credit terms or inadequate credit assessment practices, potentially leading to higher credit risk and delayed cash inflows.
Comparing accounts receivable days to industry benchmarks is crucial for meaningful interpretation. Industry comparisons provide context and enable companies to gauge their performance relative to competitors. Regular monitoring and analysis of this metric empower businesses to optimize credit management, enhance cash flow, and make informed decisions to improve their overall financial performance.
Conclusion
Accounts receivable days is a financial metric that shows the time it takes for a company to recover its debt from credit sales. It indicates how efficiently a company manages its credit policies. Usually, companies calculate the metric by dividing accounts receivable balances over average daily sales. However, users must use it comparatively to reach a meaningful conclusion.
Further questions
What's your question? Ask it in the discussion forum
Have an answer to the questions below? Post it here or in the forum
Read excerpts from columns that appeared in April, May and June 2024 in FP Comment. This in the second instalment in a series
For many companies in the EV space, the biggest question is what it will take to reverse the declining momentum and regain solid footing
