What Is the Receivables Turnover Ratio?

The receivables turnover ratio measures how many times a company successfully collects its average 澳洲幸运5官方开奖结果体彩网:accounts receivable balance over a certain period (usual꧋ly a year). This ratio helps companies monitor cash flow by quantifying the effectiveness of their payment collection efforts.

Understanding Receivables Turnover Ratios

To calculate the receivables turnover ratio, a company needs to divide its 澳洲幸运5官方开奖结果体彩网:net credit sales by its average accounts receivable. This gives an estimate of how often a company collects its receivables. This ratio is usually calculated on a monthly, quarterly, or annual basis, and it can be used to help companies measure current 澳洲幸运5官方开奖结果体彩网:cash flow trends and identify opportunities for improvement.

⛦ Understanding The Components of the Receivables Turnover Ratio

Two essential elements are needed to calculate the r𓆏🍬eceivables turnover ratio: net credit sales and average accounts receivable.

Net Credit Sales

Net credit sales refers to how much revenue a company earns, specifically revenue paid as credit. The sale must incur an accounts receivable balance in order to be considered a “net credit sale,” meaning cash sales aren’t included.

To calcu𓄧late net credit sales, a business takes its gross credit sales (the volume of all sales inc𝓰urring an accounts receivable balance) and subtracts customer returns or discounts. This is important, because businesses will need to calculate the net credit sales during a specific period of time, often a month or quarter. If a customer returns an item outside of that period (say the following month), the return will still need to be applied to the net credit sales calculation.

For example, if Joe’s Bakery made $50,000 in gross credit sales♍ during one month and received $1,000 in returns (even if some of those returns happened🍌 in the following month). Their net credit sales would be $49,000.

Average Accounts Receivable

To calculate the ratio, you’ll need to know the balance of your average accounts r♊eceivable. In other words, how ꩵmuch do you generally maintain in outstanding customer payments? Companies can determine this amount by calculating the difference between starting accounting receivables balances and ending balances. 

Depending on the company’s 澳洲幸运5官方开奖结果体彩网:accounting software, this in🐠formation may be automatica🙈lly calculated and presented—sometimes on a daily basis. It will be important to ensure the only data included in the ratio coincides with a specific time period (such as one month or quarter).  

For example, if Joe’s Bakery has an accounts receivable balance of $5,000 at the start of the month and $10,000 at the end of the month, the company would add the two balances together and divide by two to find the average accounts receivable for the 🍬month:

Average accounts receivable: ($5,000 + $10,000) / 2 = $7,500

Example of Receivables Turnover Ratio

Company A has net credit sales of $1,000,000 for the year. On January 1, their starting accounts receivable balance was $70,000. On🐼 December 31, their ending accounts receivable balance was $85,000. 

First, calculate the average accounts receivable:
($70,000 + $85,000) / 2 = $77,500

Next, let’s use the information above to determine the accounts receivable turnover ratio:
$1,000,000 in net credit sales / $77,000 in average accounts receivable = 12.98

Based on the data provided during this time period, Company A collects its accounts receivables and converts thatꦫ credit to cash 12.98 times on average per year.

More specifically, we can deduce:

365 days per year / 12.98 = The average duration of accounts receivable is approximately 28 days. 

If Company A h𓄧as a net 30-day payment policy, a 28-day turnover ratio indicates that customers are paying about two days early on average. 

Company A can use this information to justify its customer credit structure or payment polic꧟y, as it indicates their current processes are generally effective.

How the Rece🍒ivables Turnover Ratio Correlates with Cash Flow

The time between the sale of a product or service and payment can impact 澳洲幸运5官方开奖结果体彩网:cash flow. Unles🌱s all outstanding costs are owed upfront (ex., a cash sale at a grocery store or clothing store), a business is essentially loaning customers the funds owed until it’s time to collect.

It’s not unusual for businesses to give clients 30 days or longer to pay for a product or service. That’s the time during which the business could be reinvesting in itself, 澳洲幸运5官方开奖结果体彩网:paying down debts,🐼 or otherwise ad☂dressing its own financial obligations.

The receivables turnover ratio can help a company understand its existing cash flow trend. The higher the ratio, the moreಌ efficient the company is at collecting outstanding account balances. The lower the ratio, the more inefficient they may be—meaning the company converts its accounts rece🅰ivable to cash less often. 

By tracking the receivables tu𒆙rnover ratio, businesses can gain insight into their collection efficiency and take actions to improve cash flow, such as adjusting customer payment terms or improving credit collection strategies.

Ad🤡vantages and Di🙈sadvantages of the Receivables Turnover Ratio

While the receivables turnover ratio can help companies conduct internal compariso💯ns to previous periods, it may be difficult to compare ratios across the industry.

Re💯ceivable﷽s Turnover Ratio vs. Asset Turnover Ratio

Th🔯e receivables turnover ratio measures𝐆 a company’s ability to effectively collect outstanding payments from customers. The asset turnover ratio, however, measures how effectively a company is able to use its assets to generate revenue. In both cases, the higher the ratio, the more efficiently the company is operating.

The Bottom Line

Most companies and corporations✃ invoice for their services, though the terms of payment vary greatly. These variances can impact a business’s ability to meet their cash flow needs, pursue new financial ventures, and otherwise continue operating efficiently. Calculating the receivables turnover ratio regularly can help companies track their payment collection efforts and identify potential areas for improvement.