What problems may be indicated by an average collection period that is substantially above or below the industry average?
The average collection period is a financial metric that measures the average number of days it takes for a company to collect payments from its customers. A substantially high or low average collection period compared to the industry average can indicate various problems. Let's explore them:
1. Above the industry average:
- Inefficient credit and collection policies: A longer average collection period may suggest ineffective credit policies or collection procedures. It could mean that the company is extending credit to customers who are unable or hesitant to make timely payments.
- Cash flow issues: If customers are taking significantly longer to pay than the industry average, it can create cash flow problems for the company. This can impact the liquidity and financial stability of the business.
- Poor customer creditworthiness: A higher average collection period might indicate customers' declining creditworthiness. It could mean that customers are facing financial difficulties and are struggling to meet their payment obligations.
2. Below the industry average:
- Stringent credit policies: A lower average collection period suggests that the company has implemented strict credit policies and collection practices. While this can lead to faster cash inflows, excessively strict policies may restrict sales and customer acquisition.
- Aggressive collection practices: A lower collection period could indicate aggressive collection efforts, such as demanding immediate payment or implementing penalties, which might put strain on customer relationships.
- High-quality customer base: A below-average collection period can also indicate that the company has a high-quality customer base, consisting of financially stable customers who promptly settle their dues.
To identify the specific problems associated with an above or below industry average collection period, further analysis of the company's credit policies, collection procedures, and customer base is necessary.