How to Find the Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio is a financial metric used to evaluate a company’s effectiveness in managing the credit it extends to customers. This ratio indicates how efficiently a business collects payments from its credit sales. Understanding this metric helps assess a company’s liquidity and the operational efficiency of its credit policies.

Understanding Accounts Receivable Turnover

Accounts receivable turnover is an efficiency ratio that measures how many times a company collects its average accounts receivable balance over a specific period, typically a year. It provides insight into the speed at which a business converts its credit sales into cash.

The purpose of this ratio is to assess a company’s ability to collect outstanding debts efficiently. A higher turnover suggests that a company is effective in its credit collection efforts and has customers who pay their debts promptly. This efficiency directly impacts a company’s liquidity, as timely collection of receivables ensures a steady inflow of cash.

For businesses, investors, and creditors, the accounts receivable turnover ratio is an important indicator. Prompt collection of receivables contributes positively to working capital management and supports healthy cash flow, which is essential for ongoing operations and financial stability.

Key Data for Calculation

To determine the accounts receivable turnover ratio, two primary figures are needed: net credit sales and average accounts receivable. The formula for this calculation is Net Credit Sales divided by Average Accounts Receivable. These figures are found on a company’s financial statements.

Net credit sales represent the total revenue generated from sales made on credit, after accounting for any returns, allowances, or discounts. It is important to exclude cash sales from this figure, as they do not create accounts receivable. This net amount provides a more accurate measure of the sales that contribute to outstanding customer balances. Businesses find their net credit sales figure on the income statement.

Average accounts receivable is the average amount of money owed to the company by its customers over a specific period. To calculate this, the beginning accounts receivable balance for the period is added to the ending accounts receivable balance for the same period, and the sum is then divided by two. These beginning and ending balances are found on the company’s balance sheet for two consecutive periods.

Performing the Calculation

Calculating the accounts receivable turnover ratio involves a straightforward application of the formula using the identified financial data. This process quantifies how frequently a business collects its average outstanding customer balances.

First, identify the net credit sales for the period. For example, if a company had gross credit sales of $1,000,000, with $50,000 in sales returns and allowances, its net credit sales would be $950,000.

Next, determine the beginning and ending accounts receivable balances for the same period. For instance, if the accounts receivable balance at the start of the year was $100,000 and at the end of the year was $150,000, these are the figures to use. Using these figures, ($100,000 + $150,000) / 2 equals an average accounts receivable of $125,000.

Finally, apply the accounts receivable turnover formula by dividing the net credit sales by the average accounts receivable. Continuing the example, dividing $950,000 (net credit sales) by $125,000 (average accounts receivable) results in an accounts receivable turnover ratio of 7.6. This calculation indicates that the company collected its average accounts receivable 7.6 times during the period.

Analyzing Your Turnover Ratio

Interpreting the accounts receivable turnover ratio provides valuable insights into a company’s financial practices and customer payment behaviors. The ratio’s meaning is relative and should be considered within a broader context. A higher ratio suggests efficient credit collection. This indicates that a company is converting its credit sales into cash more quickly, which points to good liquidity. A high ratio can also imply that the company has a customer base that pays its invoices promptly or that it maintains conservative credit terms.

Conversely, a low accounts receivable turnover ratio can signal inefficiencies in the collection process. This might suggest that the company is experiencing delays in collecting payments, potentially leading to cash flow problems. A lower ratio could also indicate issues such as overly lenient credit terms, a higher risk of bad debts, or a less effective collection department.

To gain meaningful insights, it is important to compare the calculated ratio to several benchmarks. Comparing it to industry averages helps determine how a company performs relative to its competitors. Analyzing the company’s historical trends for the ratio can reveal improvements or deteriorations in its collection efficiency over time. Comparing the ratio to direct competitors also provides a clearer picture of its competitive standing in managing receivables.