Average collection period is the time taken by the business to receive the cash payment from the customers who have bought the goods on credit from the company. Milwaukee Surgical Supplies is selling 100% on credit but the customers return cash within a month. On an average, it takes 27 days to receive the cash from the customers. The 30% of the customers pay in 10 day, 40% in 30 days and 30% in 40 days. Home Infusion’s average collection period (ACP), also called days in patient accounts receivable, is 20 days. ACP = (0.5 × 15 days) + (0.5 × 25 days) = 20 days.
Less days of collection period is cost-effective for a company as less funds are tied up.
Due to the credit policy of Milwaukee Surgical Supplies, about $90,000 of the company is always tapped in receivables. The company thinks of reducing this balance by following a strict policy for non-discounted customers from 40 to 30 days. It will reduce the average collection period by 3 days and the receivables outstanding will be $80,000. Home Infusion’s receivable balance would be $20,000. This is quite less as compared with Milwaukee.
If the company follows a strict collection policy, it is able to save $800 as the carrying expense on $90,000 at 8% will be $7,200 and if the company is able to reduce the receivables to $80,000, the carrying expense will be 80000 x 8%= 6400. Both the companies have an 8% interest. Home infusion will pay only $1,600 as outstanding is 20,000 but Milwaukee has a higher outstanding balance so it will have to pay at