The accounts receivable days is an efficiency measure that evaluates the efficiency of the business in collecting payments. Therefore, it deduces the efficiency by which the company utilizes its assets.
And there is no particular standard to measure how good or bad an accounts receivable days ratio is for a company. This is because this ratio will vary from business to business and industry to industry, and therefore, no particular number of days is considered to be a perfect number.
That said, the number of accounts receivable days that is 25% above the payment terms stated on the invoice is considered optimal.
However, the number of days that are too close to the one stated in the payment terms on the sales invoice indicates a harsh credit policy being used by the company, which is not considered good as the company may be losing out on potential customers.
Similarly, if the number of days in which payment is recollected is long, this is an indication of very lenient payment terms and could create problems for the business. However, as mentioned previously, what is considered to be a long or a short period varies from one industry to another.
Accounts receivable days is the number of days an invoice remains unpaid or outstanding until the business finally collects the payment from the customer.
Businesses often extend credit to their customers wherein the payments for the sales made arrive later. This also causes cash flow issues for some businesses. In order to figure out how efficient the cash collection cycle is, businesses use the account receivable days.
The accounts receivables days measure the business’s ability to collect shirt term payments effectively, in a timely manner. The formula used to calculate account receivable days is applied to the total payments due to be collected from the customers rather than for anyone invoice due from a customer in particular.
However, when applied to a single customer’s outstanding invoices, it can be useful in finding out how much time that customer is taking to clear his outstanding invoices and hence helps to figure out if that customer is causing cash flow problems due to taking more time to pay back. This can allow the business to improve its efficiency in collecting payments.
Some techniques that could be utilized to improve accounts receivable days include using the direct debit method to take payments from customers.
This allows the company to collect payments from customer’s bank accounts directly when they become due, ensuring that delays in receiving payments are considerably reduced. Other methods to increase payment collection efficiency include introducing a stricter credit policy.
In order to mark improvement in the efficiency of cash collection, a company can chart monthly calculations of accounts receivable days over a time period using a trend line and then compare and contrast to see the progress of any efforts towards improving it.
Using an aged accounts receivables report to supplement the accounts receivable days will allow seeing which particular invoices remained unpaid for the longest time, allowing the company to work on particular customers who make late payments.
Formula for Accounts Receivable Days
The accounts receivable days are calculated using the following formula. The Total Accounts Receivable for a year is divided by the Annual Revenue and multiplied by the total number of days in a year. This formula can be written as:
Accounts Receivable Days= (Accounts Receivable/Revenue) x 365 days
Calculation for Accounts Receivable Days
The following is an example of the calculation of accounts receivables days:
Consider Company A which has a total of $100,000 Accounts Receivable for the year. The net revenue for the year is $600,000. The accounts receivable days can be calculated by:
$100,000/$600,000 x 365 days= 60.83 days
The accounts receivable days obtained above imply that the company collects payments from its customers in 60.83 days.
In this situation, if the company’s payment terms were net 30, a 60 day accounts receivable period would mean that it takes the company double the time to be able to collect its due invoices. In such cases, the company would need to reduce its accounts receivable days.
To conclude what has been said above, calculating the accounts receivable days provides an opportunity for the company to understand its efficiency in being able to collect payments from its customers.
This provides significant insight into understanding the success of the company’s credit policy and its ability to evaluate how the company’s cash cycle can be improved. It is perhaps one of the initial steps that are taken towards achieving an improved cash cycle.
This is because the accounts receivable days allow the company to understand how effectively it is utilizing its assets and where most of the cash is stuck up. The optimum number of accounts receivable days varies from industry to industry and will be different for only businesses with seasonal demand.