Accounts Receivable Turnover Ratio: Definition & Examples

Investors could take an average of accounts receivable from each month during a 12-month period to help smooth out any seasonal gaps. It measures the value of a company’s sales or revenues relative to the value of its assets and indicates how efficiently a company uses its assets to generate revenue. A low asset turnover ratio indicates that the company is using its assets inefficiently to generate sales. A low ratio could be the result of inefficient collection processes, inadequate credit policies, or customers who are not financially viable or creditworthy. Keeping up with your accounts receivable is key to maximizing cash flow and identifying opportunities for financial growth and improvement.

Although this metric is not perfect, it’s a useful way to assess the strength of your credit policy and your efficiency when it comes to accounts receivables. Plus, if you discover that your ratio is particularly high or low, you can work on adjusting your policies and processes to improve the overall health and growth of your business. With certain types of business, such as any that operate primarily with cash sales, high receivables turnover ratio may not necessarily point to business health. You may simply end up with a high ratio because the small percentage of your customers you extend credit to are good at paying on time. A high AR turnover ratio means a business is not only conservative about extending credit to customers, but aggressive about collecting debt.

The receivable turnover ratio, otherwise known as the debtor’s turnover ratio, is a measure of how quickly a company collects its outstanding accounts receivables. Using your receivables turnover ratio, you can determine the average number of days it takes for your clients or customers to pay their invoices. Since the receivables turnover ratio measures a business’ ability to efficiently collect itsreceivables, it only makes sense that a higher ratio would be more favorable. Higher ratios mean that companies are collecting their receivables more frequently throughout the year. For instance, a ratio of 2 means that the company collected its average receivables twice during the year.

What Is Receivables Turnover?

AR turnover ratio is also not especially helpful to businesses with a high degree of seasonality. In these cases, it’s more helpful to pay attention to accounts receivable aging. In industries like retail where payment is usually required up front or on a very short collection cycle, companies will typically have high turnover ratios. For example, some companies use total sales instead of net sales when calculating their turnover ratio.

The accounts Receivable Turnover Ratio serves more of a purpose than simple bookkeeping. It enables a business to have a complete understanding of how quickly payments are being collected. This leads to more cash in hand and opportunities for strategic planning. The Accounts receivable turnover ratio is calculated by dividing net credit sales by the average accounts receivable.

By submitting this form, you agree that PLANERGY may contact you occasionally via email to make you aware of PLANERGY products and services. Ensure you’re sending invoices on time, and that every invoice is complete and accurate. All that said, a high turnover ratio is generally considered to be better than a low turnover ratio. Line Of CreditA line of credit is an agreement between a customer and a bank, allowing the customer a ceiling limit of borrowing.

Further, if your business is cyclical, your ratio may be skewed simply by the start and endpoint of your accounts receivable average. Compare it to Accounts Receivable Aging — a report that categorizes AR by the length of time an invoice has been outstanding — to see if you are getting an accurate AR turnover ratio. A bigger number can also point to better cash flow and a stronger balance sheet or income statement, balanced asset turnover and even stronger creditworthiness for your company. Secondly, the ratio enables companies to determine if their credit policies and processes support good cash flow and continued business growth — or not. The days’ sales in accounts receivable ratio tells you the number of days it took on average to collect the company’s accounts receivable during the past year. Beverages, it appears the company is doing a good job managing its accounts receivable because customers aren’t exceeding the 30-day policy. Had the answer been greater than 30, a wise investor will try to find out why there were so many late-paying customers.

Module 15: Financial Statement Analysis

Cash sales result in an upfront payment, so these don’t create receivables. It’s useful to compare a company’s ratio to that of its competitors or similar companies within its industry. Looking at a company’s ratio, relative to that of similar firms, will provide a more meaningful analysis of the company’s performance rather than viewing the number in isolation. For example, a company with a ratio of four, not inherently a “high” number, will appear to be performing considerably better if the average ratio for its industry is two. These entities likely have periods with high receivables along with a low turnover ratio and periods when the receivables are fewer and can be more easily managed and collected. The ratio also measures the times that receivables are converted to cash during a certain time period. A high AR turnover ratio is usually desirable, but not if credit policies are too restrictive and negatively impact sales.

Let’s say your company had $100,000 in net credit sales for the year, with average accounts receivable of $25,000. To determine your accounts receivable turnover ratio, you would divide the net credit sales, $100,000 by the average accounts receivable, $25,000, and get four. The accounts receivable turnover ratio is an accounting calculation used to measure how effectively your business uses customer credit and collects payments on the resulting debt. Lastly, many business owners use only the first and last month of the year to determine their receivables turnover ratio. However, the time it takes to receive payments often varies from quarter to quarter, especially for seasonal companies.

Accounts Receivable Turnover Is All About Efficiency

Accounts receivable are monies owed to the company when they allow customers to pay for purchases over a specified period of time. The receivable turnover ratio quantifies a company’s ability to collect liabilities/debts. It helps investors gauge the efficiency of a company’s collection and credit policies. This shows, on average, a company has 36.5 days of outstanding receivables.

CEI offers a more accurate reflection of collections and credit performance with fluctuating sales. CEI can provide insights into collections teams’ performance and how quickly accounts receivables turn into closed accounts. Businesses should have the following information handy to calculate CEI. A good accounts receivable turnover depends on how quickly a business recovers its dues or, in simple terms — how high or low the turnover ratio is. With a 30-day payment policy, if the customers take 46 days to pay back, the Accounts Receivable Turnover is low.

The Data Dilemma: Prioritize These KPIs To Unleash the Full Potential of Your Accounts Receivable

Owl Wholesales’ annual credit sales are $90 million ($100 million – $10 million in returns). Their starting and ending receivables are $10 million and $14 million, which means their average accounts receivable balance is $12 million. Some corporate lenders will also look at a businesses’ accounts receivable turnover ratio to assess their financial health. Businesses hoping to secure funding or receive credit will want to ensure their receivables turnover is in a healthy place. Tracking accounts receivable turnover ratio shows you how quickly the company is converting its receivables into cash on an average basis. Finance teams can use AR turnover ratio when making balance sheet forecasts, as it provides a general expectation of when receivables will be paid. This allows companies to forecast how much cash they’ll have on hand so they can better plan their spending.

With Versapay, you can deliver custom notifications automatically and direct customers to pay online, eliminating much of your team’s need for collections calls. Collaborative accounts receivable automation software can help businesses invoice faster, proactively manage overdue payments, and address what is often the biggest contributor to late payments—disputes.

• Now that you understand what an accounts receivable turnover ratio is and how to calculate it, let’s take a look at an example.
• Instead, it would be smart to invest in a software solution that will keep everything in one place.
• Lastly, when it comes to comparing different companies’ accounts receivables turnover rates, only those companies who are in the same industry and have similar business models should be compared.
• This bodes very well for the cash flow and personal goals in the small doctor’s office.
• Sales Returns – When customers send previously purchased products back to the seller due to the product/merchandise being defective, damaged, or unsatisfactory.

Add the two receivables numbers ($1,183,363 + $1,178,423) and divide by two. An A/R turnover ratio of 4 means ABC Company was able to collect its average A/R balance ($325,000) about four times throughout the year. In real life, it is sometimes hard to get the number of how much of the sales were made on credit.

Accounts Receivable Turnover Analysis

Lower turnover ratios indicate that your business collects on its invoices inefficiently and is cause for concern. Once you know your accounts receivable turnover ratio, you can use it to determine how many days on average it takes customers to pay their invoices . It means that a company collects payments from its customers relatively quickly, without a long waiting period. A high-efficiency ratio means that the company has high-quality customers who pay their debts in due time.

• I’m a subcontractor, I completed all the flatwork for a new construction home.
• If your company’s cash flow cycle isn’t strong, you may want to review your AR ratio.
• If you can’t find “credit sales” on an income statement, you can use “total sales” instead.
• Lower turnover ratios indicate that your business collects on its invoices inefficiently and is cause for concern.
• It is calculated by dividing net credit sales by average accounts receivable.

A debtor’s turnover ratio demonstrates how effective their collections process is and what needs to be done to further collect on late payments. The longer the days sales outstanding , the less working capital a business owner has.

First off, the ratio is an effective way to spot trends, but it can’t help you to identify bad customer accounts that need to be reviewed. In addition, the ratio can be skewed by particularly fast or slow-paying customers, giving a less than accurate picture of your overall collections process. You can use the accounts receivables turnover calculator below to promptly evaluate how efficient a company is at collecting from its customers by entering the required numbers. Accounts receivable turnover measures how efficiently a company uses its asset.

We’ll also discuss the usefulness in calculating the turnover by the number of days. A high ratio value indicates an efficient and effective credit policy, and a low ratio indicates a debt collection problem. Some businesses boast of an excellent AR turnover ratio, but it doesn’t mean there are no areas for continued development. For instance, excel-based calculators can help calculate AR turnover Ratio. With metrics like DSO on a monthly/quarterly/yearly basis, a business can detect when it’s about to hit a roadblock. If you can’t find “credit sales” on an income statement, you can use “total sales” instead.

In comparison, an accounts receivable turnover decrease means a company is seeing more delinquent clients. Lastly, when it comes to comparing different companies’ accounts receivables turnover rates, only those companies who are in the same industry and have similar business models should be compared. Comparing the accounts receivables turnover ratio of companies of varying sizes or capital structures is not particularly useful and you should use caution in doing so. Furthermore, a low accounts receivable turnover rate could indicate additional problems in your business—ones that are not due to credit or collections processes. When companies fail to satisfy customers through shipping errors or products that malfunction and need to be replaced, your company’s turnover may slow.

Reward Efficient Payments

Colgate’s accounts receivables turnover has been high at around 10x for 5-6 years. Compare The Turnover RatiosTurnover Ratios are the efficiency ratios that measure how a business optimally utilizes its assets to generate sales from them.

• The ratio also measures how many times a company’s receivables are converted to cash in a certain period of time.
• To get further insight into your finances, examine how many days it takes to collect receivables by dividing your turnover ratio by 365.
• Generally, the higher the accounts receivable turnover ratio, the more efficient a company is at collecting cash payments for purchases made on credit.
• Now for the final step, the net credit sales can be divided by the average accounts receivable to determine your company’s accounts receivable turnover.
• Bring scale and efficiency to your business with fully-automated, end-to-end payables.
• But this may also make him struggle if his credit policies are too tight during an economic downturn, or if a competitor accepts more insurance providers or offers deep discounts for cash payments.

If one company has a much higher receivables turnover ratio than the other, it may be a safer investment. We look at what both high and low turnover ratios mean a little further below. The AR balance is based on the average number of days in which revenue will be received. Revenue in each period is multiplied by the turnover days and divided by the number of days in the period to arrive at the AR balance.

Receivables Turnover: Definition, Formula & Example

Both measures capture the same information but in a slightly different way. Whereas, a low or declining accounts receivable turnover indicates a collection problem from its customer. When you hold onto receivables for a long period of time, a company faces an opportunity cost. Therefore, reevaluate the company’s credit policies to ensure timely receivable collections from its customers.

A well-optimized accounts receivable turnover ratio is an important part of bookkeeping. It’s essential when preparing an accurate income statement and balance sheet forecast. Ensuring it falls within the standards determined by your company’s credit policies can also help you maintain a healthy cash flow and preserve positive relationships with your clients. A low accounts receivable turnover ratio or a decrease in accounts receivable turnover ratio suggests that a company lacks efficient collection strategies to collect receivables on time.

To calculate average accounts receivable, simply find the total of beginning and ending accounts receivable for a certain period and divide it by 2. A strong relationship with your clients will help you understand their needs and demands, which might result in extending the credit period. This way it’s convenient for them to pay on time as well as build a healthy business rapport between both parties resulting in an increased receivable turnover ratio. In this section, we’ll look at Alpha Lumber’s financial data to calculate its accounts receivable turnover ratio. Then, we’ll discuss what the company’s ratio says about its current status and identify areas for improvement.

What is Accounts Receivable (AR) turnover ratio?

She most recently worked at Duke University and is the owner of Peggy James, CPA, PLLC, serving small businesses, nonprofits, solopreneurs, freelancers, and individuals. It doesn’t matter how busy everyone in your company is — if invoices do not go out on time, then money will not come in on time either. https://www.bookstime.com/ Accounting software can help you automate many aspects of the invoicing process and can guard against errors such as double billing. By knowing how quickly your invoices are generally paid, you can plan more strategically because you will have a better handle on what your future cash flow will be.