Accounts receivable days is the number of days that a customer invoice is outstanding before it is collected. The point of the measurement is to determine the effectiveness of a company's credit and collection efforts in allowing credit to reputable customers, as well as its ability to collect cash from them. The measurement is usually applied to the entire set of invoices that a company has outstanding at any point in time, rather than to a single invoice. When measured at the individual customer level, the measurement can indicate when a customer is having cash flow troubles, since it will attempt to stretch out the amount of time before it pays invoices.
There is not an absolute number of accounts receivable days that is considered to represent excellent or poor accounts receivable management, since the figure varies considerably by industry and the underlying payment terms. Generally, a figure of 25% more than the standard terms allowed represents an opportunity for improvement. Conversely, an accounts receivable days figure that is very close to the payment terms granted to a customer probably indicates that a company's credit policy is too tight. When the credit policy is too tight, a company is potentially turning away sales (and profits) by denying credit to customers who are more likely than not to be able to pay the company.
The formula for accounts receivable days is:
(Accounts receivable ÷ Annual revenue) x Number of days in the year
For example, if a company has an average accounts receivable balance of $200,000 and annual sales of $1,200,000, then its accounts receivable days figure is:
($200,000 accounts receivable ÷ $1,200,000 annual revenue) x 365 days
= 60.8 Accounts receivable days
The calculation indicates that the company requires 60.8 days to collect a typical invoice.
An effective way to use the accounts receivable days measurement is to track it on a trend line, month by month. Doing so shows any changes in the ability of the company to collect from its customers. If a business is highly seasonal, a variation is to compare the measurement to the same metric for the same month in the preceding year; this provides a more reasonable basis for comparison.
No matter how you use this measurement, remember that it is usually compiled from a large number of outstanding invoices, and so provides no insights into the collectibility of a specific invoice. Thus, you should supplement it with an ongoing examination of the aged accounts receivable report and the collection notes of the collection staff.
The following are all possible methods for reducing the number of accounts receivable days:
- Tighten credit terms, so that financially weaker customers must pay in cash
- Call customers in advance of the payment date to see if payments have been scheduled, and to resolve issues as early as possible
- Install collections software to increase the efficiency of the collections staff
- Hire support staff to handle paperwork for the collections personnel, so more time is spent contacting customers
- Involve more aggressive collections assistance, such as a law firm, earlier in the collections process
- Be willing to take back goods if a customer cannot pay