How to use the Average Collection Period formula to reduce Days Sales Outstanding

The Average Collection Period (ACP), also known as Days Sales Outstanding (DSO), can be calculated using the following formula:

Alternatively, it can be expressed as:

Both formulas measure the same concept, giving you insight into how efficiently your business collects payments from customers.

Example: If your Average Accounts Receivable (AR) is $200,000 USD and your net credit sales over the last 12 months total $1,000,000 USD, your calculation for ACP would be:

ACP = (200,000 ÷ 1,000,000) × 365 = 73 days.

This means that, on average, you wait 73 days to convert an invoice into cash, which is well past the typical Net 30 terms. Understanding how to properly utilize the average collection period formula helps you evaluate your accounts receivable management and identify potential areas for improvement. 

An accurate ACP empowers finance professionals to evaluate their accounts receivable management critically and uncover opportunities for process enhancements. 

Read this article to learn how to calculate DSO effectively and implement strategies that can significantly boost your cash flow and operational efficiency.

Why this number matters: the strategic case in one page

The ACP reflects your organization’s efficiency in converting sales into cash. When your ACP stands well beyond your Net 30 payment terms, you're facing several significant business issues that can jeopardize operational stability and growth:

• Locked cash: With money tied up in overdue invoices, your cash flow becomes constrained, limiting your ability to react quickly to new opportunities or unexpected expenses.
  
  
• Higher financing costs: Extended collection periods often require businesses to seek additional financing, adding interest costs and reducing overall profitability.
  
  
• Bad-debt risk: The longer invoices remain unpaid, the higher the likelihood that they will become uncollectible, directly impacting your bottom line and increasing your bad-debt ratio.
  
  
• Staff burnout and administrative overhead: Continuous manual chasing of overdue payments can lead to staff fatigue and inefficiency, diverting resources away from strategic initiatives to focus on collections.

Using ACP as a benchmark allows finance leaders to set informed performance standards and triggers for action. If your ACP consistently exceeds both your payment terms and industry averages, it's a strong indicator that your receivables process needs to be evaluated and potentially corrected.

This metric is vital for understanding your working capital and optimizing cash conversion,  both of which are integral to your Cash Efficiency Index (CEI). As a result, ACP shouldn't be dismissed as a secondary metric; improving it can have a meaningful impact on your company’s financial health..

Businesses that identify and address high ACP can boost their cash flow, ease financial pressure, and support their growth. Acting on this metric helps prevent losses and helps your organization succeed in a competitive market.

How to calculate ACP correctly: Step-by-step (3 easy methods)

Calculating your Average Collection Period accurately is essential for effective financial management. Here are three methods to determine your ACP, each suitable for different business scenarios.

Method A: Standard 12-month ACP (recommended for most businesses)

• Compute average accounts receivable (AR):
  • Average AR = (Beginning AR + Ending AR) ÷ 2
    
    
• Use Net Credit Sales for the same 12-month period. Ensure you're using credit sales only, as this excludes cash sales.
  
  
• Multiply by 365 to convert the calculation into days.
  • ACP = (Average AR ÷ Net Credit Sales) × 365

Example:

• Average AR: Beginning AR =$150,000 USD
  
  
• EndingAR = $250,000 USD.
  • Average AR = (150,000 + 250,000) ÷ 2 = $200,000 USD
    
    
• Net Credit Sales for the last 12 months = $1,000,000 USD

Using the formula:

• ACP = (200,000 ÷ 1,000,000) × 365 = 73 days

Pitfall to avoid: Mixing monthly AR figures with annual sales figures without adjusting the “days” will lead to incorrect results. 

For example, comparing average accounts receivable from one month ($120,000 USD for June) with annual credit sales ($1,200,000 USD) and dividing by 365 days would yield an average collection period (ACP) of 36.5 days. While this may appear favorable, it is mathematically inaccurate.

The correct method would result in an ACP of 30 days, as June's AR should only be compared to June's credit sales over 30 days.

Method B: Rolling 3- or 6-month ACP (better for fast-moving businesses)

This method is particularly useful for seasonal businesses or those undergoing recent process changes, as it provides a more current view of cash flow management. 

To calculate:

• Use a rolling period of either 3 or 6 months for your calculations.
  
  
• Adjust the “Number of Days” in the formula to reflect the chosen period; for instance, use 90 days for a 3-month ACP or 180 days for a 6-month ACP.

The formula remains:

As a short example, let’s assume a company has the following financial data over the last 3 months:

• Average accounts receivable: $150,000 USD
  
  
• Net credit sales: $600,000 USD
  
  
• Chosen rolling period: 3 months (90 days)

The formula for calculating their ACP would look something like this:

• Average accounts receivable: $150,000
  
  
• Net credit sales: $600,000
  
  
• Chosen rolling period: 3 months (90 days)
  
  
• Substitute into the formula:
  ACP = (150,000 ÷ 600,000) × 90
  
  
• Calculate:
  ACP = 0.25 × 90
  
  
• Result:
  ACP = 22.5

This means the company's Average Collection Period over the 3 months is 22.5 days.

Method C: Value-weighted / invoice-level DSO (best for prioritization)

This method allows you to see which customers are inflating your ACP by assessing the days' sales outstanding (DSO) weighted by invoice value or customer-level average days to pay.

• For each invoice, determine the days it takes to get paid.
  
  
• Weight each invoice's DSO against its total value.
  
  

Example:

• Customer A pays $5,000 USD in 90 days.
  
  
• Customer B pays $50,000 USD in 30 days.

To calculate the weighted DSO:

• Weighted DSO = [(90 days × 5,000) + (30 days × 50,000)] ÷ (5,000 + 50,000)
  
  
• Weighted DSO = (450,000 + 1,500,000) ÷ 55,000 = 34.55 days
  
  

Why weighting matters: In this scenario, focusing solely on average days could mask the reality that while Customer A is a long-time payer, Customer B significantly influences cash flow due to their substantial invoice size.

By utilizing these three methods, you can reliably calculate your ACP and gain actionable insights into your receivables management. These insights allow your business to identify trends in cash flow, prioritize collections more effectively, and target specific customers who may need additional support in payment. 

Ultimately, by understanding your ACP through these methods, you can enhance your cash flow, debt collection efficiency, reduce the risk of bad debt, and allocate resources more strategically, driving overall financial health and supporting sustainable growth.

What different ACP ranges mean (and what to do next)

Understanding the implications of your ACP is crucial for effective financial management. 

Outlined below are clear thresholds based on your ACP in relation to your payment terms, along with actionable next steps to optimize your collections strategy.

ACP ≤ payment terms (e.g., ≤ Net 30): Green zone

Interpretation: Your collections process is operating efficiently. The ACP aligns with your payment terms, indicating that customers are generally paying on time.
Action:

• Continue to monitor performance regularly.
  
  
• Consider making small process tweaks if needed, but major changes are unnecessary at this stage.
  
  

ACP slightly above terms (e.g., 31–45 days over Net 30): Amber zone

Interpretation: Your average collection period is edging beyond your ideal payment terms, which suggests customers may be slowing their payments.
Action:

• Tighten payment terms temporarily to encourage faster settlements.
  
  
• Implement earlier reminders and shorter follow-up Service Level Agreements (SLAs) to catch issues before they escalate.
  
  

ACP materially above terms (e.g., >45 days over Net 30): Red zone

Interpretation: Your collections cycle is significantly lagging behind expected payment timelines, representing a potential cash flow risk.
Action:

• Consider implementing automation tools to streamline your accounts receivable process.
  
  
• Prioritize high-value invoices and customers for immediate attention.
  
  
• Assess whether you need to increase headcount in your finance team to manage follow-ups effectively.
  
  
• Treat this as a critical funding risk that could affect your overall business operations.
  
  

Immediate concrete checks to run

To better understand the context of your ACP and its implications, consider running the following checks:

1. Compare ACP to net terms: Ensure you clearly see how your ACP stacks up against your payment terms.
   
   
2. Check % current AR: Evaluate the proportion of current accounts receivable that could provide insight into potential cash shortfalls.
   
   
3. Compute average days delinquent: This metric will help you understand how long your overdue receivables have been outstanding.
   
   
4. Calculate collection efficiency index: This index provides context for your cash flow performance relative to your operating cycle, guiding you on resource allocation and improvements.

3-step playbook to shorten ACP

This straightforward approach will help you identify and address the factors contributing to an extended ACP. With a focus on actionable steps, you can enhance your collections process and improve cash flow.

Step 1: Prioritize the invoices that move the needle

To effectively shorten your ACP, begin by triaging your invoices based on critical factors. Use rules such as:

• Value × days overdue: Focus on invoices that have a high outstanding amount and are overdue for a significant duration.
  
  

• Payer rating: Assess customers based on their payment history. Prioritize customers who have a rating indicating prompt payment.
  
  

• Dispute likelihood: Gauge the likelihood of disputes based on the invoice type or customer history. Prioritize straightforward invoices while flagging those that may require additional follow-up due to past disputes.

Prioritization Rule Example: Chase invoices that are greater than $5,000 USD and have been overdue for more than 30 days first.

Quick micro-tactics:

• Schedule outreach for high-value accounts earlier in the collection timeline, ensuring you engage them promptly.
  
  

• Establish a value-based SLA for escalation of unpaid invoices, wherein you escalate follow-ups and communications based on the invoice value.

This tactical approach allows finance teams to concentrate their efforts where they will have the most significant impact.

Step 2: Remove manual friction and make it easy to pay

Simplifying the payment process for your customers is essential for reducing delays in collections. Consider implementing the following practical tactics:

• Include payment links: Embed payment links directly in your reminders to streamline the payment process.
  
  

• Offer multiple payment methods: Cater to customers’ preferences by accepting a variety of payment methods, such as credit cards, direct debits, and digital wallets.
  
  

• Use one-click payment portals: Create a seamless experience by enabling customers to complete multi-channel payments with just a click.
  
  

• Auto-reconcile payments: Implement systems that automatically reconcile payments to reduce friction between accounts payable and accounts receivable.
  
  

Copy example for an email reminder:

Focusing on conversion-friendly strategies will help encourage faster payments and improve your cash flow.

Step 3: Add automation and prioritized visibility (when and how to invest)

As you work to reduce your ACP, consider the role of automation in your collections strategy. The key return on investment (ROI) trigger for automation occurs when the ACP gap is large or becomes a repeatable issue. Investing in automation pays off by:

• Shortening time-to-first-reminder: Automated systems can send reminders quickly, significantly reducing the time from due date to first contact.
  
  

• Standardizing follow-up: Automation ensures that follow-up communications are consistent and timely, enhancing customer engagement.
  
  

• Freeing staff capacity: By automating routine tasks, your finance team can focus on higher-value activities, such as building customer relationships and resolving disputes.

Decision framework:

• If the ACP gap is small, focus on improving processes and tightening payment terms.
  
  

• If the gap is large and persistent, it’s time to invest in automation.

How receivablesAR automation actually shortens ACP

Automation in accounts receivable is designed to enhance operational efficiencies, ultimately leading to a significant reduction in your ACP. By linking your ACP diagnosis to specific operational features, you can create lasting value through improved processes:

Feature-to-benefit mapping:

• Automated multi-channel chasing (email/SMS/letters/auto-calls) → Enables earlier, consistent follow-ups that increase recovery rates, ensuring customers are reminded about outstanding invoices across various platforms.
  
  

• Payment portal & Chaser pay (one-click payments + auto-reconciliation) → Reduces friction and administrative overhead, turning reminders into instant cash flow by facilitating quick and convenient transactions.
  
  

• Prioritized visibility (value-weighted DSO, payer ratings) → Allows your team to focus on collecting invoices that truly move cash, enabling you to strategically direct resources and efforts where they matter most.
  
  

• Predictive risk & forecasting → Helps you act before invoices go bad, significantly reducing ADD and mitigating the risk of bad debt by identifying at-risk accounts early.
  
  

• Centralized communications + AI drafts → Streamlines dispute resolution and ensures consistent audit trails, allowing for faster response times and improved communication across the board.

FHC Accountants saw a notable impact from AR automation, reporting a “54 days reduction in DSO,” showcasing how effective these features can be in real-world scenarios.

By leveraging these impactful features of AR automation, businesses not only enhance their collections process but also foster a more predictable cash flow environment.

To get started with improving your collections process, download the Chaser AR dashboard template to visualize and manage your accounts receivable more effectively.

Quick wins you can ship this week (low lift, high impact)

Implementing small, actionable changes to your accounts receivable process can yield significant benefits. Here are several quick wins you can execute this week to drive immediate improvements in your cash flow and reduce your average collection period:

• Send first reminder at day seven instead of day thirty
  Expected effect: Early cash collection. Initiating contact sooner increases the likelihood of prompt payments.
  Time-to-value: Immediate.
  
  
• Add one-click payment link to all outgoing invoices and reminders
  Expected effect: Simplifies the payment process, reducing friction and facilitating quicker transactions.
  Time-to-value: Immediate implementation. Results will be seen within payment cycles.
  
  
• Run a top-10 overdue list by value and assign a senior collector to the top three
  Expected effect: Focus efforts on high-value invoices, increasing the likelihood of recovery.
  Time-to-value: Short-term. You will see immediate attention on high-impact accounts.
  
  
• Add a simple “payment options” line to email templates to remove friction
  Expected effect: Provides clarity for customers on how to pay, potentially speeding up payments.
  Time-to-value: Immediate. This can be integrated into existing communications.
  
  
• Reconcile the last 3 months to identify the top five customer culprits inflating ACP
  Expected effect: Identify problematic accounts, allowing for targeted interventions and discussions.
  Time-to-value: Short-term. You will gain insights within days of reconciliation.
  
  
• Automate late payment reminders
  Expected effect: Increase consistency and reduce manual workload.
  Time-to-value: Immediate. Once set up, the system runs independently and improves follow-up efficiency.
  
  

Example subject lines and email template

Sending effective reminder emails is crucial for encouraging timely payments. Here are some example subject lines and a body template to help you communicate clearly and effectively with your customers:

Example subject lines:

• “Friendly Reminder: Invoice #[Invoice Number] Due Soon!”
  Sets a positive tone while stressing the urgency of the invoice due date.
  
  
• “Quick Reminder: Outstanding Invoice #[Invoice Number]”
  Direct and to the point, highlighting the fact that there is an unpaid invoice that needs attention.
  
  
• “Your Invoice #[Invoice Number] is Coming Due – Don’t Forget!”
  A friendly nudge that signals the customer to make sure they take action before the deadline.
  
  
• “Payment for Invoice #[Invoice Number] is Past Due”
  Clear and concise, this subject line emphasizes urgency while remaining professional.

Template body:

By executing these micro-actions, you can create a ripple effect in your collections process. This will enhance cash flow and contribute positively to your overall ACP. All of this can be achieved within the same week. Focus your efforts on these quick wins, and watch as your receivables management becomes more efficient and effective.

If you're facing significant challenges with your ACP, it's time to take action. Book a demo with Chaser today to see how our accounts receivable automation can streamline your collections process, improve cash flow, and help you recover outstanding invoices faster. Don’t let delays impact your business—discover the solution that can make a difference!

Measuring success: KPIs to track and how to prove ROI

Effectively measuring the success of your accounts receivable automation efforts is crucial for understanding the impact on your cash flow and overall financial health. Below are key performance indicators (KPIs) to track, along with guidance on how to compute and compare them:

Primary success metrics:

• Average collection period/Days sales outstanding
  Goal: Fall to or below your payment terms.
  How to compute: Calculate ACP using the formula:
  ACP = (average accounts receivable ÷ net credit Sales) × 365
  • Regularly compare this against your payment terms (e.g., Net 30) to evaluate collections efficiency.
    
    

• Collection Effectiveness Index (CEI)
  Aiming for: Near-100% post-improvement.
  How to compute: Calculate using the formula: CEI = (amount collected ÷ total amount due) × 100. 
  • Assess how much of the outstanding debt you successfully collect, offering insight into the effectiveness of your collection strategies.
    
    

• Average Days Delinquent
  Goal: Approach 0.
  How to compute: ADD can be calculated by averaging the number of days overdue for outstanding invoices: ADD = (Total Days Overdue ÷ Number of Overdue Invoices)
  • A reduction in ADD indicates faster recovery of outstanding invoices.
    
    

• Bad debt ratio and accounts receivable turnover
  Trending: Down for bad debt ratio and up for AR turnover.
  
  How to compute:
  • Bad debt ratio:
    Bad debt ratio = (Bad debts ÷ Total credit sales) × 100
    
    
  • AR turnover:
    AR turnover = (Net credit sales ÷ average accounts receivable)
    A declining bad debt ratio combined with a rising AR turnover indicates improved financial health.
    
    

• Percentage of current accounts receivable (% Current AR)
  Should: Increase over time.
  How to compute: % Current AR = (current accounts receivable ÷ total accounts receivable) × 100
  • A higher percentage of current AR signifies more timely payments from customers.
    
    

Recommended cadence

• Compute ACP monthly: Ensure that you are consistently tracking your ACP and making adjustments as necessary.
  
  
• Trend over 3–12 months: Identify patterns and seasonality in your collection data by reviewing trends over a more extended period.
  
  
• Report value-weighted DSO weekly for the collections team: This will help your team maintain focus on the most critical accounts and provide timely updates on performance.
  
  

Attributing cash recovered to actions

To prove the return on investment (ROI) of your accounts receivable automation efforts, link specific actions to outcomes. For example:

• Earlier reminders: By sending reminders at day 7 instead of day 30, you can measure the resulting uplift in payments over the first 14 days. Track the percentage of invoices paid within this timeframe before and after implementing the change.
  
  
• Reduced friction from payment links: Monitor the uplift in payments following the integration of payment links in reminders. A measurable increase in payments can be directly attributed to simplifying the payment process.
  
  

By consistently tracking these KPIs and attributing cash recovered directly to specific actions, you can effectively demonstrate the ROI of your accounts receivable initiatives and make data-driven decisions to further optimize your collections strategies.

FAQs and common calculation mistakes (short clarifications)