The way it does this is by establishing a period of time for average accounts receivable and net credit sales.įor example, if a business is calculating its accounts receivable turnover for a 90-day period, it would take the net credit sales over the 90-day period and divide it by the average accounts receivable balance for the period. The formula for calculating accounts receivable is:ĪR Turnover Ratio = Net Credit Sales ÷ Average Accounts ReceivableĮarlier we mentioned that the accounts receivable turnover ratio takes into account time. How To Calculate The Accounts Receivable Turnover Ratio This makes the ratio intuitively easy to understand when comparing multiple companies across the same industry. In general, as a business becomes more efficient at converting credit sales to cash the accounts receivable turnover ratio is higher. One of the benefits of ratio analysis is that it allows analysts to compare multiple companies across the same sector and industry. The ratio is also a measurement of how long it takes a business to convert credit sales to cash over a given period of time. At its core, the ratio tells us how many times a business converted its receivables to cash over a period of time. The end result is a ratio that quantifies how effective a business is at collecting its receivables. The accounts receivable turnover ratio is a calculation that compares the net credit sales over a period of time to the average accounts receivable balance for the same period. What Is The Accounts Receivable Turnover Ratio? In this post we will cover what the accounts receivable turnover ratio is, how to calculate accounts receivable turnover, and how to interpret the results. It is often used to compare multiple companies across the same industry or sector to identify which ones are best at converting customer credit to cash.īecause cash is so important, both corporate and investment finance professionals monitor accounts receivable turnover regularly to identify if a business faces potential liquidity or solvency issues. The calculation indicates that the company requires 60.8 days to collect a typical invoice.The accounts receivable turnover ratio is an important efficiency metric used by management and investors to understand how many times a business converts its receivables to cash over a period of time. If a company has an average accounts receivable balance of $200,000 and annual sales of $1,200,000, then its accounts receivable days figure is: Thus, you should supplement it with an ongoing examination of the aged accounts receivable report and the collection notes of the collection staff. No matter how this measurement is used, remember that it is usually compiled from a large number of outstanding invoices, and so provides no insights into the collectability of a specific invoice. If a business is highly seasonal, a variation is to compare the measurement to the same metric for the same month in the preceding year this provides a more reasonable basis for comparison. Doing so shows any changes in the ability of the company to collect from its customers. (Accounts receivable ÷ Annual revenue) x Number of days in the year = Accounts receivable daysĪn effective way to use the accounts receivable days measurement is to track it on a trend line, month by month. The formula for accounts receivable days is: When this is the case, a company is potentially turning away sales (and profits) by denying credit to customers who are more likely than not to be able to pay the company. Conversely, an accounts receivable days figure that is very close to the payment terms granted to a customer probably indicates that a company's credit policy is too tight. Generally, a figure of 25% more than the standard terms allowed represents an opportunity for improvement. There is not an absolute number of accounts receivable days that is considered to represent excellent or poor accounts receivable management, since the figure varies considerably by industry and the underlying payment terms. The measurement is usually applied to the entire set of invoices that a company has outstanding at any point in time, rather than to a single invoice. When measured at the individual customer level, the measurement can indicate when a customer is having cash flow troubles, since it will attempt to stretch out the amount of time before it pays invoices. The point of the measurement is to determine the effectiveness of a company's credit and collection efforts in allowing credit to reputable customers, as well as its ability to collect cash from them in a timely manner. Accounts receivable days is the number of days that a customer invoice is outstanding before it is collected.
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