Receivable Turnover Ratio Definition, Formula, and Calculation

This could also be due to a conservative credit policy where the company avoids extending credit to customers with poor credit history to prevent unnecessary loss of revenue. However, a restrictive credit policy may limit business growth and negatively impact sales. 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 (for credit sales). If Company A has a strict payment policy of 30 days, the accounts receivable turnover days indicate that customers are paying late.

How To Efficiently Manage Your Company’s Account Receivables

Once you have fixed the credit period for your clients make sure to follow up on them regularly until they pay their dues. This is a great way to increase this ratio as it motivates the clientele of yours to pay faster and be punctual for all future transactions resulting in increased revenue generation. A strong relationship with your clients will help you understand their needs and demands, which might result in extending the credit period. The net credit sales come out to $100,000 and $108,000 in Year 1 and Year 2, respectively.

Similar to calculating net credit sales, the average accounts receivable balance should only cover a very specific time period. If you have a high accounts receivable turnover ratio, this could mean you have managed your cash flow well, and have maintained stronger creditworthiness. By proactively notifying your customers about their payment with personalized communications, you improve your chances of getting paid before receivables become overdue and speed up accounts receivable turnover. With Versapay, you can deliver custom notifications automatically and direct customers to pay online, eliminating much of your team’s need for collections calls.

Step 3: Divide your net credit sales by average accounts receivable

If you have outstanding receivables, reminders can also help to collect payments from customers who are overdue. If you have a low ratio, consider ways you can improve your accounts receivable processes and efficiency. This could include implementing better policies for handling late payments, or adding automation to your AR process to speed activity based budgeting up the steps needed. The accounts receivable turnover ratio is a great metric to evaluate your performance, and leveraging resources like Moody’s Analytics Pulse can help you improve your ratio.

What a low accounts receivable turnover ratio means

It tells you that your collections team is effectively following up with customers about overdue payments. A high ratio also indicates that the company has a generally strong customer base, as customers tend to pay their invoices on time. Owl Wholesales’ annual credit sales are $90 million ($100 million – $10 million in returns).

Why Is It Crucial to Measure Accounts Receivable Turnover Ratio?

Average receivables is calculated by adding the beginning and ending receivables for the year and dividing by two. While accounts receivable turnover ratio provides a great way to quickly measure your collection efficiency, it has its limitations. Conversely, a low AR turnover ratio could mean the company is not very discerning with whom it extends credit to, creating a higher risk of bad debt. A low ratio could also mean that there are barriers impeding the collections process. Your AR team might be understaffed or lack the right knowledge and tools to excel at collections.

Versapay’s AR automation solution allows your customers to raise any issues by leaving a comment directly on their invoice. Giving customers the opportunity to self-serve also reduces the number of inquiries coming into your AR department, contributing to faster collection times. Delivering invoices in a more convenient format also increases customers’ likelihood of paying you faster, improving your collection efficiency. Because AR departments historically experience a high degree of manual work, streamlining collections processes is the easiest way to improve accounts receivable turnover. There are also factors that could skew the meaning of a high or low AR turnover ratio, which we’ll cover when discussing the limitations of accounts receivable turnover ratio as a key performance indicator.

Businesses rely on a steady cash flow to operate smoothly, especially during times of economic uncertainty. A simple and efficient method for tracking timely individuals payments is through effective management of accounts receivable. Another example is to compare a single company’s accounts receivable turnover ratio over time.

Finally, you’ll divide your net credit sales by your average accounts receivable for the same period. To calculate your accounts receivable turnover, you’ll need to determine your net credit sales. To do this, use an AR turnover formula that takes your total sales made on credit and subtracts any returns and sales allowances. You should be able to find this information on your income statement or balance sheet. Generally, the higher the accounts receivable turnover ratio, the more efficient a company is at collecting cash payments for purchases made on credit. High accounts receivable turnover ratios are more favorable than low ratios because this signifies a company is converting accounts receivables to cash faster.

In this blog post, we will explore the definition and formula of the accounts receivable turnover ratio formula in detail. 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. At the end of the year, Bill’s balance sheet shows $20,000 in accounts receivable, $75,000 of gross credit sales, and $25,000 of returns. The net credit sales can usually be found on the company’s income statement for the year although not all companies report cash and credit sales separately.

It centers around how many times you convert your receivables into cash within a specific time frame — usually monthly, quarterly, or annually. In AR, the accounts receivable turnover ratio is used to establish and improve the efficiency of a company’s revenue collection process over a given time period. The accounts receivable turnover ratio is an important metric — but it’s still hypothetical and leaves room for assumptions. While this metric could state that a company’s credit policy might be too lax or conservative, it doesn’t elaborate the ‘why’ behind the numbers.

1. 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.
2. Industries like manufacturing and construction typically have longer credit cycles (e.g., 90-day terms), which makes lower AR turnover ratios normal for companies in those sectors.
3. There’s no standard number that distinguishes a “good” AR turnover ratio from a “bad” one, as receivables turnover can vary greatly based on the kind of business you have.

A company may track its accounts receivable turnover ratio every 30 days or at the end of each quarter. In this manner, a company can better understand how its collection plan is faring and whether it is improving in its collections. For example, if the company’s distribution division is operating poorly, it might be failing to deliver the correct goods to customers in a timely manner. As a result, customers might delay paying their receivables, which would decrease the company’s receivables turnover ratio. Companies with more complex accounting information systems may be able to easily extract its average accounts receivable balance at the end of each day. The company may then take the average of these balances; however, it must be mindful of how day-to-day entries may change the average.

For instance, a ratio of 2 means that the company collected its average receivables twice during the year. In other words, this company is collecting is money from customers every six months. Accounts receivable turnover ratio, also known as receivables turnover ratio or debtor’s turnover ratio, is a measure of efficiency. It refers to the number of times during a given period (e.g., a month, quarter, or year) the company collected its average accounts receivable. CEI is an essential metric for tracking accounts receivable and offers a more accurate reflection of collections and credit performance with fluctuating sales.