A collection period refers to the amount of time that it takes a vendor to collect on a debt. Most day-to-day transactions, such as at a gas station or grocery store, are made with a “due upon receipt” collection period. This means that a purchase is paid at the same time the purchase is made. In some industries, however, it is common for a customer to be invoiced for product already received. The customer typically has anywhere from 1-30 days to pay an invoice, but negotiations can be made to pay an invoice over a period of months or even years.
When one buys a pair of shoes at a department store, for example, cash or credit is exchanged on site in order for the purchase to be made. This is often not the same for business-to-business purchasing, where it is common for the vendor to invoice the customer for goods already received. The amount of time it takes for the customer to pay the invoice is called a collection period.
A vendor may stipulate the terms of an invoice generated for a company. These terms are stated as “Net 30” or “Net 45” which means that the invoice is due in 30 or 45 days. This does not mean, however, that the customer will definitely pay the invoice during that time period. Many customers stretch out the payment of invoices for 60-90 days or more. It is up to the vendor to decide if the customer pays a penalty for late payment or if additional credit may be suspended until all invoices are current.
The management of cash flow during the collection period is critical for the overall successful operation of any company. When a manufacturer processes an order, it has to pay for the cost of goods either up front or on invoiced account. Then the goods have to be processed and shipped to the customer. In the meantime, payment is due to the original supplier while the customer has yet to pay for the goods. Therefore, manufacturers need capital in reserve to be able to pay invoices on time while waiting for an eventual payment from the customer.
To decrease the length of a collection period, a vendor may use an incentive to encourage faster payment. This is called a prompt pay discount. A vendor may offer a 2% discount if the invoice is paid in 10 days, for example. The terms of such an invoice would be “2% 10 Days Net 30”, for example, which means that there is a 2% discount if the invoice is paid within 10 days, and the balance is due in 30 days from the date of the invoice.
Debt collectors can be hired to decrease the length of the collection period as well. A debt collector will approach the list of people that owe a company money and attempt to collect on those debts in a swift manner. A debt collector, however, charges a fee for the service, typically a percentage of the amount collected.
