Total credit sales minus returns and allowances for the period.
((Beginning AR + Ending AR) / 2) for the period.
Your Results
—
Average Accounts Receivable: —
Net Credit Sales: —
Days Sales Outstanding (DSO): —
Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable.
Days Sales Outstanding (DSO) = 365 Days / Accounts Receivable Turnover.
Accounts Receivable Turnover Trend
Visualizing your Accounts Receivable Turnover and Days Sales Outstanding over time.
Understanding how efficiently a business collects its outstanding payments is crucial for maintaining healthy cash flow and financial stability. The Accounts Receivable Turnover ratio is a key performance indicator that measures this efficiency. It tells you how many times a company collects its average accounts receivable balance during a specific period. A higher turnover generally indicates better liquidity and more effective credit and collection policies.
What is Accounts Receivable Turnover?
The Accounts Receivable Turnover ratio, also known as Debtors Turnover Ratio, is a financial metric used to assess a company's ability to collect on its credit sales. It quantifies how many times a company can turn its accounts receivable into cash over a given period, typically a year. Essentially, it measures the effectiveness of a company's credit and collection processes.
Who should use it?
Businesses: To monitor their own collection efficiency and identify potential issues with credit policies or customer payment habits.
Investors: To gauge the financial health and operational efficiency of a company they are considering investing in.
Creditors/Lenders: To assess the risk associated with extending credit to a business. A low turnover might suggest a higher risk of bad debts.
Financial Analysts: For comparative analysis between companies in the same industry or tracking a company's performance over time.
Common Misconceptions:
Higher is always better: While a high turnover is generally good, an excessively high ratio might indicate overly strict credit policies that could be hindering sales growth.
It's the only measure of collection: It should be analyzed alongside other liquidity ratios and industry benchmarks for a complete picture.
Applies to all sales: This ratio specifically focuses on credit sales, not cash sales.
Accounts Receivable Turnover Formula and Mathematical Explanation
Calculating the Accounts Receivable Turnover ratio is straightforward. It involves dividing the company's net credit sales by its average accounts receivable balance for the period.
The formula is:
Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
To gain further insight, this ratio is often used to calculate the Days Sales Outstanding (DSO), which represents the average number of days it takes for a company to collect payment after a sale has been made on credit.
The formula for DSO is:
Days Sales Outstanding (DSO) = 365 Days / Accounts Receivable Turnover Ratio
Variable Explanations:
Variable
Meaning
Unit
Typical Range
Net Credit Sales
Total revenue generated from credit sales during a period, minus any sales returns, allowances, and discounts. It represents the actual amount owed by customers for goods or services delivered on credit.
Currency (e.g., USD, EUR)
Varies widely by industry and company size.
Accounts Receivable (AR)
The total amount of money owed to a company by its customers for goods or services delivered on credit.
Currency (e.g., USD, EUR)
Varies widely by industry and company size.
Average Accounts Receivable
The average balance of accounts receivable over a specific period. It's calculated by summing the beginning accounts receivable balance and the ending accounts receivable balance for the period and dividing by two. This smooths out fluctuations.
Currency (e.g., USD, EUR)
Varies widely by industry and company size.
Accounts Receivable Turnover Ratio
Measures how many times a company collects its average accounts receivable balance during a period. A higher ratio indicates more efficient collection.
Times per period (e.g., times per year)
Industry-dependent; often compared to benchmarks.
Days Sales Outstanding (DSO)
The average number of days it takes to collect payment after a sale is made on credit. A lower DSO is generally preferred.
Days
Industry-dependent; often compared to credit terms.
Practical Examples (Real-World Use Cases)
Example 1: A Growing E-commerce Business
Scenario: "GadgetGlow," an online retailer specializing in electronic gadgets, wants to assess its collection efficiency for the last fiscal year.
Inputs:
Net Credit Sales: $750,000
Beginning Accounts Receivable: $80,000
Ending Accounts Receivable: $120,000
Calculation:
Average Accounts Receivable: ($80,000 + $120,000) / 2 = $100,000
Accounts Receivable Turnover: $750,000 / $100,000 = 7.5 times
Days Sales Outstanding (DSO): 365 / 7.5 = 48.67 days
Interpretation: GadgetGlow collects its average accounts receivable balance 7.5 times per year. On average, it takes them approximately 49 days to collect payment after a sale. This might be acceptable if their standard credit terms are Net 60, but concerning if they are Net 30, suggesting potential delays in collection or issues with their credit management process.
Example 2: A Stable Manufacturing Company
Scenario: "SteelWorks Inc.," a long-established steel manufacturer, is reviewing its annual performance.
Inputs:
Net Credit Sales: $5,000,000
Beginning Accounts Receivable: $400,000
Ending Accounts Receivable: $600,000
Calculation:
Average Accounts Receivable: ($400,000 + $600,000) / 2 = $500,000
Accounts Receivable Turnover: $5,000,000 / $500,000 = 10 times
Days Sales Outstanding (DSO): 365 / 10 = 36.5 days
Interpretation: SteelWorks Inc. turns over its receivables 10 times annually, with an average collection period of about 37 days. If their typical credit terms are Net 30, this indicates they are collecting payments relatively promptly, which is a positive sign for their cash flow management. If their terms are Net 60, they might consider tightening credit policies or improving collection efforts to reduce the DSO.
How to Use This Accounts Receivable Turnover Calculator
Our calculator simplifies the process of determining your company's Accounts Receivable Turnover and Days Sales Outstanding (DSO). Follow these simple steps:
Enter Net Credit Sales: Input the total value of your credit sales for the period (e.g., a quarter or a year), ensuring you subtract any returns, allowances, or discounts.
Enter Average Accounts Receivable: Calculate your average AR balance for the same period. If you don't have monthly data, use the beginning and ending balances for the period: (Beginning AR + Ending AR) / 2.
Click 'Calculate': The calculator will instantly display your Accounts Receivable Turnover ratio and the calculated Days Sales Outstanding (DSO).
How to Read Results:
Accounts Receivable Turnover: A higher number means you're collecting cash from your credit sales more frequently. Compare this to previous periods and industry averages.
Days Sales Outstanding (DSO): A lower number indicates faster collection. Compare this to your stated credit terms (e.g., Net 30). If your DSO is significantly higher than your terms, it signals a potential problem.
Decision-Making Guidance:
High DSO (relative to terms): Consider reviewing your credit policies, improving your invoicing process, or implementing more proactive collection strategies.
Low DSO (relative to terms): You might be collecting cash very efficiently, potentially even faster than necessary. You could explore offering slightly more lenient terms to attract more customers or improve sales volume.
Industry Benchmarks: Always compare your results to industry averages. What's considered good in one sector might be poor in another. Understanding your industry financial ratios is key.
Key Factors That Affect Accounts Receivable Turnover Results
Several factors can influence your Accounts Receivable Turnover ratio and DSO, impacting your company's liquidity and operational efficiency:
Credit Policies: The strictness of your credit approval process directly impacts who buys on credit and their likelihood of timely payment. Lenient policies may increase sales but also increase DSO and bad debt risk.
Collection Efforts: The effectiveness and promptness of your collection department's follow-up on overdue invoices significantly affect how quickly receivables are converted to cash.
Economic Conditions: During economic downturns, customers may face financial difficulties, leading to slower payments and a lower turnover ratio. Conversely, a booming economy might see faster collections.
Industry Norms: Different industries have varying typical payment cycles. For example, industries with long sales cycles or large transaction values might naturally have higher DSos than those with quick, small transactions.
Customer Base: The financial health and payment behavior of your specific customer base play a huge role. A concentration of customers with poor credit history will negatively impact turnover.
Invoicing Accuracy and Timeliness: Errors or delays in sending out invoices can postpone the start of the payment clock, increasing DSO. Clear, accurate, and prompt invoicing is essential.
Payment Methods Offered: Offering a variety of convenient payment options (online portals, credit cards, ACH) can encourage faster payments compared to traditional methods.
Discounts for Early Payment: Offering small discounts (e.g., 2/10, net 30) can incentivize customers to pay sooner, thereby improving the turnover ratio.
Frequently Asked Questions (FAQ)
Q1: What is considered a good Accounts Receivable Turnover ratio?
A: A "good" ratio is highly industry-dependent. Generally, a higher ratio is better, indicating efficient collection. However, it's crucial to compare your ratio to industry benchmarks and your own historical performance. A ratio significantly higher than the industry average might suggest overly strict credit terms that could be limiting sales.
Q2: How does Days Sales Outstanding (DSO) relate to Accounts Receivable Turnover?
A: DSO is derived from the turnover ratio. While turnover tells you how many times receivables are collected per period, DSO tells you the average number of days it takes to collect. They are inversely related: a higher turnover corresponds to a lower DSO, and vice versa.
Q3: Should I use total sales or net credit sales in the formula?
A: You should always use net credit sales. Accounts receivable only arise from credit sales, so including cash sales would distort the ratio. Net credit sales account for returns and allowances, providing a more accurate picture of the collectible amount.
Q4: How do I calculate Average Accounts Receivable if I only have annual data?
A: If you only have the beginning and ending AR balances for the year, you can calculate the average AR as: (Beginning AR Balance + Ending AR Balance) / 2. For more accuracy, especially if AR fluctuates significantly, use quarterly or monthly balances if available.
Q5: What if my company has very few credit sales?
A: If your company primarily operates on cash sales or has minimal credit sales, the Accounts Receivable Turnover ratio might not be a very meaningful metric. In such cases, focusing on other liquidity ratios like the Current Ratio or Quick Ratio might be more appropriate for assessing financial health.
Q6: Can seasonality affect my Accounts Receivable Turnover?
A: Yes, seasonality can significantly impact AR balances and sales throughout the year. If your business experiences seasonal peaks and troughs, using annual averages for both net credit sales and average AR provides a more stable and representative turnover ratio than looking at a single, potentially skewed, quarter.
Q7: What are the implications of a very low Accounts Receivable Turnover?
A: A low turnover ratio (and consequently high DSO) suggests that the company is taking a long time to collect payments. This can tie up working capital, increase the risk of bad debts, and potentially signal issues with credit policies, collection processes, or the financial health of customers.
Q8: How often should I calculate this ratio?
A: For effective financial management, it's recommended to calculate the Accounts Receivable Turnover ratio and DSO at least quarterly. This allows for timely identification of trends and potential problems, enabling proactive adjustments to credit and collection strategies.