The receivables turnover ratio is an accounting measure used to measure the number of times your company collects its average accounts receivable. This figure measures how effective your company is at collecting invoices and credit extended to customers and clients.
Businesses usually calculate this metric annually, but you can perform this calculation monthly or quarterly depending on your needs. If you collect invoices every 30 days or 90 days, running the receivables turnover ratio every one to three months may be a good idea.
How Do You Calculate the Receivables Turnover Ratio?
A receivables turnover ratio that’s too low can indicate some kind of difficulty with the way your business collects money. A middle-ground ratio usually means you have a steady and consistent way to get the money owed to you by clients and customers. A high ratio indicates you collect money quickly.
The formula for receivables turnover is:
Receivables turnover = net credit sales / average accounts receivables
For example, you have accounts receivable of $200,000 on January 1. You extend $500,000 of credit sales throughout the year. On December 31, your accounts receivable has $40,000.
Figure the receivables turnover ratio by doing this:
$500,000 / (($200,000 + $40,000) / 2) = 4.17
Derive the net credit sales number by taking the sales on credit and subtracting sales returns and sales allowances. Your average accounts receivable comes from adding the beginning and ending accounts receivable figures over a period of time and dividing that number by two.
What Does the Receivables Turnover Ratio Measure?
The figure of 4.17 means your company collected the average accounts receivable, or $120,000, slightly more than four times during your fiscal year. Take this formula one step further and figure how many days the average customer takes to pay an invoice. Divide 365 by the receivables turnover ratio.
365/4.17 = 87.5
Your customers pay an invoice in an average of 87.5 days in this example.
A higher turnover ratio means your accounts receivable keeps cash coming in while you send invoices out. This indicates lots of customers and a busy time. Lower turnover ratios may show you have trouble getting customers to pay or your business is slower at some points during the year.
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