Explanation of Average Collection Period:

The Average Collection Period measures the average number of days it takes for the company to collect revenue from its credit sales.  The Average Daily Sales is the Net Sales divided by 365 days in the year. The company will usually state its credit policies in its financial statement, so the Average Collection Period can be easily gauged as to whether or not it is indicating positive or negative information.

Importance of Average Collection Period:

This ratio reflects how easily the company can collect on its customers.  It also can be used as a guage of how loose or tight the company maintains its credit policies.  A particular thing to watch out for is if the Average Collection Period is rising over time.  This could be an indicator that the company's customers are in trouble, which could spell trouble ahead.  This could also indicate the company has loosened its credit policies with customers, meaning that they may have been extending credit to companies where they normally would not have.  This could temporarily boost sales, but could also result in an increase in sales revenue that cannot be recovered, as shown in the Allowance for Doubtful Accounts.