A debtor collection period is the amount of time that is required for customers of a business to receive invoicing for goods and services rendered, schedule payment for those invoices and ultimately tender that payment to the provider. Typically, the collection period begins on the date the invoice is issued and ends on the date that the payment for that invoice is posted. Companies will monitor both the debtor collection period for each individual customer and also periodically take a snapshot of the average period as it relates to the entire customer base. Doing so makes it possible to identify when the period is undergoing some sort of increase, and allow the company to take appropriate action to reduce the period to an average that is more advantageous.
The basic formula for calculating any type of debtor collection period for a customer base as a whole begins by identifying the average number of debtors relevant to the time period under consideration. This is done by identifying the number of active debtors on the first day of the period as well as the active debtors on the last day of the period. Those two figures are added and then divided by two in order to provide the necessary average.
Once the average number of debtors for the period is established, the duration of the period under consideration is identified. Depending on the reason for the calculation, the duration may be a full calendar year, a quarter, or even a week. Multiplying the average number of debtors by the duration, expressed in the number of days involved in the period, will provide the final result. In some cases, it may be appropriate to calculate the debtor collection period by using 12 months instead of 365 days, depending on how the resulting data will be used in analyzing the aging of invoices in the accounts receivables. That figure is then divided by the total number of sales generated during the period under consideration to identify the average debtor collection period for that particular time frame.
Ideally, the goal is to achieve a debtor collection period that is shorter rather than longer. For example, if the calculation indicates that the average debtor collection period is 60 days or less, this is an indication of a healthy turnover in the accounts receivables that is likely providing an equitable amount of cash flow. On the other hand, if the average collection period is more along the lines of 90 days, company owners and managers will want to look closely at current policies and procedures, as well as identify specific customers who may be contributing significantly to the longer duration, causing potential issues with cash flow.
