How to Calculate and Use the Accounts Receivable Turnover Ratio Bench Accounting

As a reminder, this ratio helps you look at the effectiveness of your credit, as your net credit sales value does not include cash, since cash doesn’t create receivables. This ratio, together with average collection period ratio, indicates how quickly a business entity can be expected to convert its credit sales into cash and thus helps evaluate deductions for sales tax the liquidity of its receivables. Like some other activity ratios, receivables turnover ratio is expressed in times like 5 times per quarter or 12 times per year etc. Since the receivables turnover ratio measures a business’ ability to efficiently collect its receivables, it only makes sense that a higher ratio would be more favorable.

Accounts Receivable Turnover Ratio: Meaning, Formula, Examples

Conversely, a lower ratio may signal issues with credit terms or collection procedures. This figure reflects the company’s ability to generate sales on credit terms. High net credit sales can be positive, but it also means the company is extending credit to its customers, and the efficiency of collecting on those sales becomes crucial. Plooto’s automation can help you manage your accounts receivable and improve your AR turnover ratio.

• All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
• Accounts receivable turnover is an efficiency ratio or activity ratio that measures how many times a business can turn its accounts receivable into cash during a period.
• The average accounts receivable represents the average amount of outstanding receivables during a given period.

What is a Good Accounts Receivable Turnover Ratio?

Also known as the “receivable turnover” or “debtors turnover” ratio, the accounts receivable turnover ratio is an efficiency ratio—specifically an activity financial ratio—used in financial statement analysis. If Alpha Lumber’s turnover ratio is high, it may be cause for celebration, but don’t stop there. Company leadership should still take the time to reevaluate current credit policies and collection processes. Then, they should identify and discuss any additional adjustments to those areas that may help the business receive invoice payments even more quickly (without pushing customers away, of course). It most often means that your business is very efficient at collecting the money it’s owed.

High receivables turnover ratios

Explore seven transformative applications and discover how is AI used in businesses for efficiency and innovation. Let’s break down the components of the Accounts Receivable Turnover Ratio formula and calculation for easy understanding. The ratio gives insight into the company’s effectiveness of converting their AR to cash. However, it’s worth noting that a high ratio could also mean that you operate largely on a cash basis as well. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.

What Affects the Accounts Receivable Turnover Ratio?

Since you can never be 100% sure when payment will come in for goods or services provided on credit, managing your own business’s cash flow can be tricky. That’s where an efficiency ratio like the accounts receivable turnover ratio comes in. A good AR-to-sales ratio for a business typically ranges between 0.5 to 1.0, indicating efficient management of accounts receivable relative to sales revenue.

To encourage cash payments, for example, you could offer a discount to customers who pay in cash. By learning how quickly your average debts are paid, you can try to determine what your cash flow will look like in the coming months in order to better plan your expenses. Plus, addressing collections issues to improve cash flow can also help you reinvest in your business for additional growth. 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.

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A high turnover ratio implies that the company is converting receivables into cash rapidly, positively impacting cash flow. This is crucial for meeting short-term obligations and making strategic investments. Below, we cover how to calculate your AR turnover ratio and what it means for your company’s financial health. Managers should continuously track their entity’s receivables turnover ratio on a trend line to observe the gradual ups and downs in turnover performance. Low A/R turnover stems from inefficient collection methods, such as lenient credit policies and the absence of strict reviews of the creditworthiness of customers. As we saw above, healthcare can be affected by the rate at which you set collections.

This income statement shows where you can pull the numbers for net credit sales. If a company can collect cash from customers sooner, it will be able to use that cash to pay bills and other obligations sooner. Adjustments to credit terms should be clearly communicated to existing and new customers, ensuring that everyone is aware of the expectations and consequences of non-compliance.

On the other hand, having too conservative a credit policy may drive away potential customers. These customers may then do business with competitors who can offer and extend them the credit they need. If a company loses clients or suffers slow growth, it may be better off loosening its credit policy to improve sales, even though it might lead to a lower accounts receivable turnover ratio.

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