Understanding the Average Collection Period
The average collection period is an important metric in accounting that measures the number of days it takes a company to collect payment from its customers. It helps assess the efficiency of a company in managing its accounts receivable. The average collection period can provide valuable insights into the company's cash flow and liquidity.
Calculation Method
To calculate the average collection period, follow these steps:
- Determine the net credit sales for the period.
- Calculate the average accounts receivable by adding the beginning and ending accounts receivable and dividing by two.
- Divide the net credit sales by the average accounts receivable to get the accounts receivable turnover ratio.
- Finally, divide 365 days by the accounts receivable turnover ratio to find the average collection period.
Answer to the Question
How is the average collection period computed?
Answer: B - by dividing 365 days by the accounts receivable turnover ratio
Explanation
The reason for choosing this answer is that the accounts receivable turnover ratio tells us the efficiency of a company in collecting its receivables. A higher turnover ratio indicates a faster collection process. Dividing 365 by this ratio gives us the average number of days it takes for the company to collect its receivables.
In conclusion, the average collection period is calculated by dividing 365 days by the accounts receivable turnover ratio, which is determined by dividing net credit sales by average accounts receivable. This metric is crucial for assessing a company's cash flow management and operational efficiency.