This is another way of stating the debtors turnover ratio. It is calculated in number of weeks (or months) taken by each debtor, on average, to pay his debt to the company. Obviously, if the rate of debtors turnover is high, average credit allowed period would be low. Conversely, if the rate of debtors turnover is low, it indicates a high average credit allowed period.
If the average credit allowed period is high, the company not only has to incur additional financial charges to finance this credit, but also runs the risk of having high bad debts, high cost of maintaining debtors records and follow up, etc. Each type of industry has a particular average credit allowed period which each company in that industry should try to stay close to, or surpass. In fact, in days of high interest rates and low productivity, allowing very long credit allowed period may expose a company to substantial losses. Effective credit control should be employed to bring down this period to as low a level as possible.
Average credit allowed period is calculated as follows if the answer is sought in weeks:
Average credit allowed period is calculated as follows if the answer is sought in months: