How to Calculate Average Days in Accounts Receivable

Accounts receivable (AR) is the money owed to your business by customers for goods or services they've purchased on credit. The average days in accounts receivable is a key metric that shows how long it typically takes for customers to pay their invoices. This calculation helps businesses assess their cash flow efficiency and financial health.

What is Average Days in Accounts Receivable?

The average days in accounts receivable (DAR) measures the average number of days it takes for customers to pay their invoices. It's calculated by dividing the average amount of accounts receivable by the net credit sales for a specific period, then multiplying by the number of days in that period.

This metric is important because it provides insight into your business's cash conversion cycle. A lower average days in accounts receivable indicates that your customers are paying their invoices more quickly, which can improve your cash flow and working capital efficiency.

How to Calculate Average Days in Accounts Receivable

To calculate the average days in accounts receivable, you'll need three key pieces of information:

Average accounts receivable (AAR)
Net credit sales (NCS)
Number of days in the period (typically 365 for a year)

The calculation involves these steps:

Calculate the average accounts receivable for the period
Calculate the net credit sales for the period
Divide the average accounts receivable by the net credit sales
Multiply the result by the number of days in the period

This gives you the average number of days it takes for customers to pay their invoices.

The Formula

The formula for calculating average days in accounts receivable is:

Average Days in Accounts Receivable = (Average Accounts Receivable / Net Credit Sales) × Number of Days

Where:

Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2
Net Credit Sales = Total credit sales - Returns and allowances
Number of Days = Typically 365 for a year, or 30 for a month

Note: The exact calculation period (month, quarter, year) should be consistent across all measurements to ensure accurate results.

Worked Example

Let's walk through a practical example to illustrate how to calculate average days in accounts receivable.

Scenario

For the year 2023, your company had the following financial data:

Beginning accounts receivable: $50,000
Ending accounts receivable: $70,000
Total credit sales: $500,000
Returns and allowances: $20,000

Step 1: Calculate Average Accounts Receivable

Average Accounts Receivable = (Beginning AR + Ending AR) / 2 = ($50,000 + $70,000) / 2 = $120,000 / 2 = $60,000

Step 2: Calculate Net Credit Sales

Net Credit Sales = Total Credit Sales - Returns and Allowances = $500,000 - $20,000 = $480,000

Step 3: Calculate Average Days in Accounts Receivable

Average Days in Accounts Receivable = (Average AR / Net Credit Sales) × Number of Days = ($60,000 / $480,000) × 365 = 0.125 × 365 = 45.625 days

In this example, the average days in accounts receivable is approximately 45.63 days.

Interpreting the Result

The average days in accounts receivable provides several insights into your business's financial health:

Cash Flow Efficiency: A lower number indicates faster payment collection, which is generally better for cash flow.
Credit Management: Helps assess how well your credit policies are working.
Industry Benchmarking: Compare your result with industry averages to see how you're performing.
Financial Health: A consistently high number might indicate issues with collections or credit policies.

Typical industry averages for average days in accounts receivable vary by sector. For example:

Retail: 25-45 days
Manufacturing: 30-60 days
Professional Services: 15-30 days

Note: These are rough estimates. Always compare with your specific industry benchmarks and historical data.

FAQ

What is a good average days in accounts receivable?: A good average days in accounts receivable varies by industry. Generally, lower numbers (closer to 30 days) indicate better cash flow efficiency. Compare your result with industry benchmarks and your company's historical data for context.
How often should I calculate average days in accounts receivable?: It's recommended to calculate this metric monthly to track trends and make timely adjustments to your credit policies. Quarterly calculations can also provide useful insights.
What factors can affect average days in accounts receivable?: Several factors can influence this metric, including credit terms offered to customers, the strength of your customer relationships, industry trends, and economic conditions.
How does average days in accounts receivable relate to cash conversion cycle?: The average days in accounts receivable is one component of the cash conversion cycle, which also includes days sales outstanding and days in inventory. Together, these metrics provide a comprehensive view of your business's cash flow efficiency.