Receivable Turnover Ratio Definition, Formula, and Calculation

receivables turnover ratio formula

The ratio shows how many times during the period, sales were collected by a business. 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. The accounts receivable turnover ratio is important because it offers insight into whether your company is struggling to collect on sales made via extending credit to customers. The ratio is a strong indicator of your company’s operational and financial performance and is a key metric in accounts receivable management. Due to declining cash sales, John, the CEO, decides to extend credit sales to all his customers. In the fiscal year ended December 31, 2017, there were $100,000 gross credit sales and returns of $10,000.

  • You can be more efficient when billing your client and boosting your cash flow, this will improve your account receivable ratio.
  • The accounts receivable turnover ratio is an accounting calculation used to measure how effectively your business (or any business) uses customer credit and collects payments on the resulting debt.
  • The lower a company’s AR turnover ratio is, the longer and more difficult it is to collect from its debtors.
  • However, it’s crucial to note that what constitutes a „good“ ratio can vary across industries.
  • Comparing the company’s ratio to industry standards provides valuable insights into its competitiveness and financial efficiency.

The receivable turnover ratio is used to measure the financial performance and efficiency of accounts receivables management. This metric helps companies assess their credit policy as well as its process for collecting debts from customers. The accounts receivable turnover ratio is an efficiency ratio and is an indicator of a company’s financial and operational performance. A high ratio is desirable, as it indicates that the company’s collection of accounts receivable is frequent and efficient.

A guide to the accounts receivable turnover ratio

The receivables turnover ratio measures the efficiency with which a company is able to collect on its receivables or the credit it extends to customers. The ratio also measures how many times a company’s receivables are converted to cash in a certain period of time. The receivables turnover ratio is calculated on an annual, quarterly, or monthly basis. The accounts receivable turnover ratio measures how effective a company is at collecting money owed by its customers or clients. The account receivable (AR) turnover ratio measures a company’s ability to collect money from its credit sales.

Lower turnover ratios indicate that your business collects on its invoices inefficiently and is cause for concern. The accounts receivable turnover ratio, also known as receivables turnover, is a simple formula that calculates how quickly your customers or clients pay you the money they owe. It also serves as an indication of how effective your credit policies and collection processes are. The accounts receivable turnover ratio measures the number of times a company’s accounts receivable balance is collected in a given period. A high ratio means a company is doing better job at converting credit sales to cash. However, it is important to understand that factors influencing the ratio such as inconsistent accounts receivable balances may accidently impact the calculation of the ratio.

Inventory Turnover

When companies fail to satisfy customers through shipping errors or products that malfunction and need to be replaced, your company’s turnover may slow. A “good” accounts receivable turnover ratio varies by industry and company size. In general, a ratio that is higher than the industry average or that shows a consistent trend of improvement is considered a positive sign. To see if customers are paying on time, you need to look for the income statement.

receivables turnover ratio formula

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. Put simply, a high receivables turnover ratio means your company uses its assets efficiently and is less likely to experience cash flow issues as a result. Assuming that this ratio is low for the lumber industry, Alpha Lumber’s leaders should review the company’s credit policies and consider if it’s time to implement more conservative payment requirements.

Examples of Good and Bad Receivables Turnover Ratio

Therefore, even among companies operating in similar industries, the ratio may not be comparable due to different business models. However, this should not discourage businesses as there are several ways to increase the receivable turnover ratio that will eventually help them improve revenue generation. Keep in mind, you will need to How to Start Your Own Bookkeeping Business For Nonprofits read through the company’s reports to find out what its collection deadline is. Regardless of whether the ratio is high or low, it’s important to compare it to turnover ratios from previous years. Doing so allows you to determine whether the current turnover ratio represents progress or is a red flag signaling the need for change.

The denominator of the accounts receivable turnover ratio is the average accounts receivable balance. This is usually calculated as the average between a company’s starting accounts receivable balance and ending accounts receivable balance. So, with net credit sales of $2,000,000 and average accounts receivable of $400,000, Company X’s receivables turnover ratio was 5.0.

How to Interpret Receivables Turnover Ratio

As a result, while calculating the average accounts receivable, the beginning and ending figures should be carefully determined to appropriately reflect the performance of the company. This means that Bill collects his receivables about 3.3 times a year or once every 110 days. In other words, when Bill makes a credit sale, it Nonprofit Bookkeeper vs Accountant Who Should You Hire? will take him 110 days to collect the cash from that sale. If a company can collect cash from customers sooner, it will be able to use that cash to pay bills and other obligations sooner. On the other hand, the cash conversion cycle accounts not just for credit sales, but also for inventory processing and credit purchases.