AR Days

Understanding Accounts Receivable (AR) Days

Accounts Receivable (AR) Days, also referred to as Days Sales Outstanding (DSO) or the Average Collection Period, measures the average number of days it takes for a company to collect payment from its customers after a sale has been made on credit.

In financial analysis and working capital management, AR Days is a vital metric. A lower number of AR Days indicates that a business collects its receivables quickly, improving cash flow and reducing credit risk. Conversely, a high number of AR Days suggests that the company is extending credit for too long, has inefficient collection procedures, or is dealing with customers who are slow to pay.

The Accounts Receivable (AR) Days Formula

The formula to calculate Accounts Receivable Days is:

\[\text{AR Days} = \left( \frac{\text{Average Accounts Receivable}}{\text{Net Credit Sales}} \right) \times \text{Days in Period}\]

Where:

• Average Accounts Receivable: The average amount of money owed to the business by customers during the period. It can be calculated as:
  \[\text{Average Receivables} = \frac{\text{Beginning Receivables} + \text{Ending Receivables}}{2}\]
• Net Credit Sales: The total sales made on credit during the period, excluding cash sales and subtracting any sales returns or allowances.
• Days in Period: The length of the period being analyzed (typically 365 days for an annual analysis, 90 days for quarterly, or 30 days for monthly).

Receivables Turnover Ratio

Another related metric is the Receivables Turnover Ratio, which shows how many times a company collects its average accounts receivable balance during a period:

\[\text{Receivables Turnover} = \frac{\text{Net Credit Sales}}{\text{Average Accounts Receivable}}\]

Using this ratio, AR Days can also be calculated as:

\[\text{AR Days} = \frac{\text{Days in Period}}{\text{Receivables Turnover}}\]

Example Calculation

Suppose a business has:

• Beginning Accounts Receivable: $10,000
• Ending Accounts Receivable: $20,000
• Net Credit Sales (annual): $100,000
• Days in Period: 365

First, calculate the average accounts receivable:

\[\text{Average Receivables} = \frac{\$10,000 + \$20,000}{2} = \$15,000\]

Next, calculate the Receivables Turnover Ratio:

\[\text{Turnover Ratio} = \frac{\$100,000}{\$15,000} \approx 6.67\text{ times per year}\]

Finally, calculate the AR Days:

\[\text{AR Days} = \left( \frac{\$15,000}{\$100,000} \right) \times 365 = 54.75\text{ days}\]

This means it takes the company an average of approximately 55 days to collect cash after making a credit sale.