What is Accounts Receivable Turnover?
Accounts receivable turnover is a financial ratio that measures how efficient a company is at collecting its outstanding debts from customers. It is calculated by dividing the net credit sales by the average accounts receivable balance during a specific period. The resulting number indicates the number of times a company collects its average accounts receivable balance during that period.
Why is Accounts Receivable Turnover Important?
Accounts receivable turnover is an important metric because it helps businesses to understand their cash flow and liquidity. A high accounts receivable turnover ratio indicates that a company is collecting its debts quickly, which means it has more cash available to invest in growth or pay off debts. On the other hand, a low accounts receivable turnover ratio indicates that a company is struggling to collect its debts, which can lead to cash flow problems and a higher risk of bad debts.
How to Calculate Accounts Receivable Turnover
To calculate accounts receivable turnover, you need to know the net credit sales and the average accounts receivable balance for a specific period. The formula for accounts receivable turnover is: Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Step 1: Calculate Net Credit Sales
Net credit sales are the total credit sales minus any returns or discounts. You can find net credit sales on the income statement. For example, if a company had total credit sales of $100,000 and $10,000 in returns and discounts, the net credit sales would be $90,000.
Step 2: Calculate Average Accounts Receivable
Average accounts receivable is the average balance of accounts receivable during a specific period. You can find the beginning and ending balances of accounts receivable on the balance sheet. To calculate the average accounts receivable, add the beginning and ending balances and divide by two. For example, if a company had a beginning accounts receivable balance of $50,000 and an ending balance of $70,000, the average accounts receivable would be $60,000.
Step 3: Calculate Accounts Receivable Turnover
Once you have calculated net credit sales and average accounts receivable, you can calculate accounts receivable turnover. Using the example numbers above, the accounts receivable turnover would be: Accounts Receivable Turnover = $90,000 / $60,000 = 1.5 times
Interpreting Accounts Receivable Turnover
The resulting number from the accounts receivable turnover calculation indicates how many times a company collects its average accounts receivable balance during a specific period. A higher number indicates that a company is collecting its debts quickly, while a lower number indicates that a company is struggling to collect its debts.
Industry Standards
Accounts receivable turnover ratios can vary depending on the industry. Some industries, such as retail, have a higher turnover ratio than others, such as healthcare. It’s important to compare your company’s accounts receivable turnover ratio to industry standards to get an accurate picture of your company’s financial health.
Trends Over Time
It’s also important to track your company’s accounts receivable turnover ratio over time. A declining ratio can indicate that your customers are taking longer to pay their debts, which can lead to cash flow problems. A rising ratio can indicate that your company is becoming more efficient at collecting debts.
Factors That Affect Accounts Receivable Turnover
Several factors can affect a company’s accounts receivable turnover ratio, including:
Credit Policies
The credit policies that a company has in place can affect its accounts receivable turnover ratio. If a company has strict credit policies, it may have a lower turnover ratio because it is only extending credit to customers who are likely to pay on time. If a company has looser credit policies, it may have a higher turnover ratio, but it may also have a higher risk of bad debts.
Customer Payment Terms
The payment terms that a company offers its customers can also affect its accounts receivable turnover ratio. If a company offers longer payment terms, it may have a lower turnover ratio because it will take longer for customers to pay their debts. If a company offers shorter payment terms, it may have a higher turnover ratio because customers will pay their debts more quickly.
Collection Efforts
The collection efforts that a company puts in place can also affect its accounts receivable turnover ratio. If a company has a dedicated collections team or uses a collections agency, it may have a higher turnover ratio because it is more effective at collecting debts. If a company does not have a collections process in place, it may have a lower turnover ratio because it is not as effective at collecting debts.
Conclusion
Accounts receivable turnover is an important financial ratio that measures how efficient a company is at collecting its outstanding debts. It’s important to calculate accounts receivable turnover regularly and compare it to industry standards to get an accurate picture of your company’s financial health. By understanding the factors that affect accounts receivable turnover, you can take steps to improve your company’s cash flow and reduce the risk of bad debts.
