The Ultimate Guide to Accounts Receivable Turnover Ratio

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Oliver Lee
October 4, 2022
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10
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Accounts Receivable Turnover Ratio How to Calculate Accounts Receivable Turnover Ratio How to Calculate Accounts Receivable Turnover Ratio Accounts Receivable Turnover Ratio

As we all know, cash is essential for the success of any organization or mid-sized business. If cash is the soul, then the accounts receivable turnover is the heart that pumps cash. Maintaining a consistent cash flow is a constant requirement; thus, collecting dues is the crux of a stable cash flow requirement. The efficiency of a company's accounts receivable process is linked to its collections process. Accounts receivable turnover ratios, for example, play an important role in helping businesses optimize collections and increase cash flow. So, to clarify, here is a guide; we have compiled everything you need to know about the accounts receivable turnover ratio.

What is the Accounts Receivable Turnover Ratio?

The accounts receivable turnover ratio quantifies the frequency with which a company collects its average accounts receivable balance. Furthermore, it measures a company's efficiency in collecting outstanding client balances and managing its line of the credit process. A productive company has a higher accounts receivable turnover ratio, while an inefficient company has a lower ratio. This metric is frequently used to compare companies in the same industry to see if they are on par with their competitors. Following are some of the main key guides for accounts receivable turnover ratio:

  • The accounts receivable turnover ratio is an accounting metric that quantifies how well a company collects receivables from its customers
  • The ratio counts the time receivables are converted to cash over a period
  • A high ratio might indicate that corporate collection practices are effective, with high-quality customers who pay their bills on time
  • A low ratio could result from inefficient collection processes, insufficient credit policies, or customers who are not financially viable or creditworthy
  • Investors should be aware that some companies calculate their ratios using total sales rather than net sales, which may inflate the results

How to Figure Out Accounts Receivable Turnover Ratio?

Accounts receivable are like short-term, interest-free loans that companies give their customers. For example, if a company sells to a client, it could extend the terms by 30 or 60 days, giving the client 30 to 60 days to pay for the product. The accounts receivables turnover ratio shows how quickly a business can collect its debts or the credit it gives customers. The ratio also shows how often a company's receivables are turned into cash over a certain period. The accounts receivables turnover ratio can be worked out once a year, thrice, or monthly. Your company will benefit a lot from figuring out this ratio. This number helps the accountant in:

  • Figuring out how well a business is at getting paid
  • How money is growing
  • Getting a sense of the average amount due for the year
  • Allowing you to compare the accounts with those of other companies

Account Receivable Turnover Formula

If the accounts receivable turnover ratio needs to be written into the business's books, it must first be calculated. The ratio between net credit sales and average accounts receivable is called the accounts receivable turnover ratio. The following is the formula to determine your business's accounts receivable turnover ratio.

Accounts Receivable Turnover Ratio

Net Credit Sales

The number in the accounts receivable turnover ratio numerator is net credit sales. This is the amount of money a company earns that is paid for on credit. This number includes cash sales, which don't affect accounts receivable. Net credit sales also include discounts or returns from customers. Net credit sales are calculated by taking gross credit sales and subtracting these reductions. A consistent time frame must be used in the calculation. So, the net credit sales should only include a certain time frame (i.e., net credit sales for the second quarter only). But if returns happen in the future, this number should be added to the calculation because it has to do with the task being looked at. Net credit sales are those in which the cash is collected later. Therefore, net credit sales are calculated as follows: Sales on credit - Sales returns - Sales allowances.

Average Accounts Receivable

The average balance of accounts receivable is used as the number in the ratio of accounts receivable turnover. This is usually found by taking the average of the beginning and ending balances of a company's accounts receivable. Companies with more complicated accounting information systems may find it easy to get their average accounts receivable balance at the end of each day. The company can then take the average of these balances, but it needs to be aware that daily transactions can change the average. Also, the average accounts receivable balance should only cover a certain period, just like how net credit sales are calculated. Average accounts receivable is calculated by dividing the sum of starting and ending accounts receivable over a while (such as monthly or quarterly) by two.

Methods for Calculating the Accounts Receivable Turnover Ratio

Step 1: Calculate Your Net Credit Sales

The primary part of the accounts receivable turnover formula calls for net credit sales or all of the sales made on credit during the year (as opposed to cash). Therefore, this estimate should include the total credit sales minus any returns or allowances. As a result, we should be able to locate the net credit sales figure in the annual income statement or Profit & Loss account.

Step 2: Determine the Average of Your Accounts Receivable

Once we have the net credit sales figure, the average accounts receivable is necessary for the second portion of the accounts receivable turnover formula. Accounts receivable are the funds owed to a company by its customers. To calculate the average accounts receivable, add the number of accounts receivable at the start of the year to the value of your accounts receivable at the end of the year and divide by two. Then, on the balance sheet, we should be able to find the necessary accounts receivable numbers.

Step 3: Make Use of the Accounts Receivable Formula

We can use the accounts receivable turnover formula once we have these two values. The net credit sales will then be divided by the average accounts receivable to calculate the accounts receivable turnover ratio, or rate.

How to Calculate Accounts Receivable Turnover Ratio

XYZ is a bicycle and biking equipment retailer. Because cash sales are declining, the CEO decides to offer credit to all of his customers. There were $100,000 in gross credit sales and $20,000 in returns in the fiscal year ending December 31, 2019. However, the year's beginning and ending accounts receivable were $5,000 and $10,000, respectively. The CEO is curious about how frequently his company collects its average accounts receivable over the year.

How to Calculate Accounts Receivable Turnover Ratio

As a result, XYZ Bikes Shop collected its average accounts receivable 5.4 times during the fiscal year ending December 31, 2019.Accounts Receivable Turnover in Days The accounts receivable turnover in days reflects the average days it takes a customer to pay the company for credit sales. The accounts receivable turnover in days formula is as follows: Accounts Receivable turnover in days = 365 / Receivable turnover ratio Calculating the accounts receivable turnover in days for XYZ Bikes Shop in the preceding example: Accounts Receivable turnover in days = 365 / 5.4 = 67.59As a result, the average customer takes 51 days to repay their debt to the store. If XYZ Bikes Shop has a policy for credit payments, such as a 30-day policy, the receivable turnover in the days calculated above would indicate that the average customer pays late. XYZ Bike Shop December 31, 2019Gross Credit Sales$10,000Returns&20,000Accounts Receivable, Beginning of the year$5,000Accounts Receivable, End of the year$10,000Accounts Receivable Turnover Ratio10.66Accounts Receivable Turnover Ratio in Days67.59

Guidelines for Improving Your Accounts Receivable Turnover Ratio

The turnover of their accounts receivable should be one of the most important things for business owners to keep an eye on. Of course, making sales and providing great customer service are important. Still, a business can't keep going if it doesn't have enough money coming in. So collecting your receivables is a sure way to improve the cash flow of your business. Following are a few things you can do to improve your Accounts Receivable turnover ratio, which will help you cut down on calls from collection agencies and improve your cash flow.

Invoice Properly

The simpler it is for your customers to pay their bills, the more accurate and detailed your invoices are. If you send out bills on time and often, your company will get paid faster. Also, if you have a payment system for your sales, your customers will find it easier to pay smaller bills regularly than one big bill every three months.

Build Strong Relationships With Your Customers

Getting paid will be easier if you have a good relationship with your customers. Customers happy with the goods and services they get are happy to pay for them. Small things like a friendly phone call or email to check in can help big and small businesses. These small things can make a difference when it's time to pay.

Include the Terms of Payment

Putting clear payment terms on your invoices is a good way to ensure they get paid. Make sure you expect to be paid within 30 days and don't be afraid to add late payment fees. Most of the time, this fee is a percentage of the original bill. Also, you might want to set credit limits or offer payment plans if you sell things for a lot.

Make Use of Cloud-based Software

Consider using accounting software in the cloud to make the whole process of billing and getting paid easier. You can get your financial information from anywhere when you work in the cloud. It makes it easy for your accounting and bookkeeping teams to work together. Also, cloud-based accounting software makes it easy to keep track of your receivables and cash flow and send invoices and reminders to your customers regularly.

Make Invoice Payment Simple

Giving your customers more ways to pay their bills will make it easier for their financial systems to work together. You'll get paid more quickly by making your customers' lives easier. You might want to accept online payments through Apple Pay or PayPal as well as cash and checks.

You Don't Have Any Accounts Receivable

Accounts Receivable problems can be avoided best by not having accounts receivable. That might not work for all businesses, but you can pay for a good or service in many fields before you get it. Online payment platforms like Square or PayPal make it possible for businesses to stop having to call people who haven't paid and risk losing money because of it. Even though these portals may have commission costs upfront, it is important to consider how much money and time you will save in the long run.

Following Up

Payment reminders don't have to come only when a payment is late. Instead, think about calling or emailing your customers ten days before the invoice is due to remind them that they need to pay. Then, as soon as the due date has passed, follow up.

Conclusion

Accounts receivable turnover is an important metric in any accounting system. This value is calculated using the accounts receivable turnover ratio, which tells executives or potential investors how efficiently the company collects payments (receivables). When the turnover ratio is high, the company usually has little to no trouble collecting payments from its customers. However, if the ratio is low, there may be room for improvement. Choosing a financial management system that can automate these processes allows businesses to spend less time worrying about cash flow and identifying customers behind on their payments. Invensis is the best option for you. Our Accounts Receivable outsourcing services ensure timely invoice generation and the delivery of monthly statements on the dates specified by the client. Furthermore, the Invensis Accounts Receivable process flow is designed to quickly convert your receivables to revenue through effective cash flow management.

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Article by
Oliver Lee

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