Accounts Receivable Turnover Ratio
The Accounts Receivable Turnover Ratio is a financial metric used to evaluate a company’s effectiveness in managing and collecting outstanding credit and receivables from its customers. It measures how efficiently a company can convert its accounts receivable into cash during a given period. The ratio is also an indicator of a company’s credit and collection policies’ effectiveness.
The formula to calculate the Accounts Receivable Turnover Ratio is:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
Where:
- Net Credit Sales: Total sales on credit during a specific period, excluding cash sales, returns, and allowances.
- Average Accounts Receivable: The average of the opening and closing accounts receivable balances during the same period.
A higher Accounts Receivable Turnover Ratio indicates that the company is efficient in collecting its credit sales from customers, implying that it has a strong credit policy and collection process in place. A lower ratio may indicate that the company has difficulties collecting payments, slow-paying customers, or issues with its credit policies.
It’s essential to note that the Accounts Receivable Turnover Ratio may vary across industries. Comparing the ratio with industry benchmarks or competitor companies can provide a better understanding of a company’s efficiency in managing its receivables.
Keep in mind that the Accounts Receivable Turnover Ratio does not consider cash sales; it focuses solely on credit sales. It’s also important to use the ratio in conjunction with other financial metrics to get a comprehensive view of a company’s financial health and efficiency.
Example of the Accounts Receivable Turnover Ratio
Let’s consider a fictional company called “OfficeFurniture Inc.” that sells office furniture to businesses on credit. We will use the Accounts Receivable Turnover Ratio to assess the company’s efficiency in collecting its credit sales from customers during a given year.
Here is the relevant financial data for OfficeFurniture Inc.:
Net Credit Sales for the year: $1,200,000 Accounts Receivable at the beginning of the year: $100,000 Accounts Receivable at the end of the year: $150,000
First, calculate the Average Accounts Receivable:
Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable) / 2 Average Accounts Receivable = ($100,000 + $150,000) / 2 = $125,000
Next, calculate the Accounts Receivable Turnover Ratio:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable Accounts Receivable Turnover Ratio = $1,200,000 / $125,000 = 9.6
The Accounts Receivable Turnover Ratio for OfficeFurniture Inc. is 9.6, which means that the company collected its outstanding receivables 9.6 times during the year. In other words, on average, OfficeFurniture Inc. collected its accounts receivable every (365 days / 9.6) = 38 days.
To assess the company’s efficiency in managing its receivables, you can compare this ratio with industry benchmarks or competitors’ ratios. A higher ratio indicates that OfficeFurniture Inc. is efficient in collecting its credit sales from customers, while a lower ratio may suggest issues with the company’s credit policies or collection process.
Remember that it’s essential to use the Accounts Receivable Turnover Ratio in conjunction with other financial metrics to get a comprehensive view of a company’s financial health and efficiency.
