Average Accounts Receivable

Credit Sales is an income statement account covering a period of time—such as one year. Accounts Receivable is a balance sheet account representing an instant or point in time. Since it could be misleading to divide the Credit Sales for the entire year by the Accounts Receivable balance at an instant at the end of just one day, one should strive to determine the average balance of Accounts Receivable during the entire year. In other words, the goal is to calculate an average balance in the Accounts Receivable account for the same one-year period as the Credit Sales.

Often the average balance in the Accounts Receivable account for a year is calculated by using the balances on just two days: the beginning of the year balance and the end of the year balance. This could also be misleading because companies' accounting years often end at their slowest time of the year and the balances in Accounts Receivable at that time will be very low and not indicative of the year. Expressed another way, if the company has its peak business season in the middle of its accounting year, using the balances in Accounts Receivable on two days outside of the peak period may be just as misleading as selecting one day at the end of the accounting year.

In order to obtain an average that is more representative of the entire year, some companies use the Accounts Receivable account balances at the end of 13 months and others compute the simple average of the 12 monthly averages.

The following illustration shows three computations of the average of the balances in Accounts Receivable for a company with a summer busy season.

Date	Balances at 2 points	Balances at 13 points	Monthly Averages
12-31-04	$ 40,000	$ 40,000
1-31-05		60,000	$ 50,000
2-28-05		70,000	65,000
3-31-05		80,000	75,000
4-30-05		100,000	90,000
5-31-05		150,000	125,000
6-30-05		250,000	200,000
7-31-05		300,000	275,000
8-31-05		200,000	250,000
9-30-05		130,000	165,000
10-31-05		60,000	95,000
11-30-05		50,000	55,000
12-31-05	60,000	60,000	55,000
Total	$ 100,000	$ 1,550,000	$ 1,500,000
No. of points	2	13	12
AVERAGE	$ 50,000	$ 119,231	$ 125,000

As you can see, using only the beginning and end of year balances (December 31, 2004 and the December 31, 2005 balances) in Accounts Receivable results in an average balance of $50,000.

Using 13 points throughout the year results in an average balance in Accounts Receivable of $119,231.

Using the average of the 12 monthly averages results in $125,000.

If you are comparing your company's financial ratios to another company's ratios or to the industry averages, it is important to keep in mind that the financial ratios can vary due to the calculations of the averages.

Because the material covered here is considered an introduction to the topic of improving profits, there are many complexities not presented. You should always consult with an accounting professional for assistance with your own specific circumstances.

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