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Hello,
Average Collection Period = [(Average Daily Trade Receivables)/(Annual Sales Revenue)] × 365
What is the logic behind the derivation of this equation? Intuitively, I can’t see why multiplying this monetary ratio by 365 days gives you the average collection period in days.
Many thanks.
Ronan
Suppose on average the receivable are 10% of the annual sales. This suggests that at any one time customers are owing 10% of the yearly sales. Given that there are 365 days in a year, then customers are owing 10% x 365 days worth of sales i.e. that they are taking that many days to pay.
Or, putting it a different way. the sales per day are total sales/365. Therefore the number of days customers are taking credit for is receivables / sales per day.
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