Collection Ratio
What is Collection Ratio
The collection ratio is a financial ratio that measures the efficiency with which a company is collecting its accounts receivable. It is calculated by dividing a company's net credit sales by its average accounts receivable. The higher the collection ratio, the more efficiently a company is collecting its accounts receivable.
The purpose of the collection ratio is to provide an indication of a company's credit management practices and the quality of its accounts receivable. A high collection ratio may indicate that a company is effectively managing its credit policies and collecting its accounts receivable in a timely manner. On the other hand, a low collection ratio may indicate that a company is having difficulty collecting its accounts receivable, which could impact its financial performance.
There are two main components of the collection ratio: net credit sales and average accounts receivable. Net credit sales are the total sales of a company on credit, minus any returns or discounts. Average accounts receivable is the average amount of money that a company is owed by its customers for goods or services that have been delivered but not yet paid for.
An example of the collection ratio would be a company with net credit sales of $100,000 and average accounts receivable of $25,000. The collection ratio for this company would be 4, calculated as follows:
Collection Ratio = Net Credit Sales / Average Accounts Receivable = $100,000 / $25,000 = 4
This indicates that the company is collecting its accounts receivable in an average of four days.
It is important to note that the collection ratio should be considered in conjunction with other financial ratios and metrics in order to get a complete picture of a company's financial performance. A high collection ratio may indicate that a company is effectively managing its credit policies and collecting its accounts receivable in a timely manner, but it may also be a result of the company having strict credit policies that limit its customer base. Similarly, a low collection ratio may indicate that a company is having difficulty collecting its accounts receivable, but it may also be a result of the company having more lenient credit policies in order to attract a larger customer base.