How to calculate average accounts receivable
/What is Average Accounts Receivable?
Average accounts receivable is a financial metric that represents the typical amount of money owed to a business by its customers over a specific period. It is calculated by adding the beginning and ending accounts receivable balances for the period and dividing the total by two. This average helps businesses analyze how efficiently they are collecting payments from customers and is commonly used in calculating key performance indicators like the accounts receivable turnover ratio and days sales outstanding (DSO).
How to Calculate Average Accounts Receivable
There are several ways to determine the average accounts receivable amount. The various techniques are noted below:
Simple average method. This method calculates average accounts receivable by taking the sum of the beginning and ending balances for the period and dividing by two. It is the most commonly used approach for short-term financial analysis. While straightforward, it may not fully capture fluctuations within the period.
Monthly average method. This approach adds the accounts receivable balances at the end of each month and divides the total by the number of months in the period. It provides a more accurate representation when there are significant changes in receivables during the period. It is especially useful for companies with seasonal sales or uneven billing cycles.
Daily average method. This method calculates the average by summing daily accounts receivable balances over a defined time frame and dividing by the number of days. It offers the most precise measurement, ideal for high-volume businesses or detailed cash flow analysis. However, it requires access to daily balance data and more complex calculations.
Average Receivables for a Seasonal Business
If you have a strongly seasonal business, the best method for calculating average accounts receivable is to average the ending accounts receivable balance for every month of the last 12 months, thereby incorporating the complete effects of seasonality into the calculation. Please note that this is a trailing 12 months calculation, so you will usually be including the receivable balance from at least a few months in the preceding fiscal year.
Average Receivables for a Growing Business
If you have a rapidly growing business, then using the average receivable balance for the last 12 months will understate the amount of receivables to be expected on a go-forward basis. Conversely, the average receivable reported for a declining business would be overstated. In these cases, it would be more accurate to average the accounts receivable over just the last three months. If the rate of growth or decline is extremely fast, then it might make more sense to calculate the average receivables figure based on just the last two months.
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When to Use Average Accounts Receivable
When should you use the average accounts receivable calculation? Lenders may want to know, so that they can estimate an average possible funding requirement. It may also be useful for the general estimation of budgeted working capital levels. However, you should not use it when conducting cash flow planning, since day-to-day variations in the actual receivable level may be very different from the long-term average. Also, always show a prospective lender your estimated accounts receivable level in every period over which lending may occur, so the lender can determine the most appropriate maximum funding level - presenting an average balance is not helpful in this situation.