How to Calculate Receivables Turnover

Receivables Turnover Calculator

Enter the financial figures below to calculate your company's receivables turnover ratio and days sales outstanding.

Calculation Results:

Average Accounts Receivable:

Receivables Turnover Ratio:

Days Sales Outstanding (DSO):

In the world of business finance, understanding how efficiently a company manages its credit sales and collects payments is crucial. One of the key metrics used for this purpose is the Receivables Turnover Ratio. This ratio provides insights into a company's effectiveness in extending credit and collecting debts from its customers.

What is Receivables Turnover?

The receivables turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its accounts receivable. It essentially shows how many times a company collects its average accounts receivable balance during a specific period, typically a year. A higher ratio generally indicates that a company is efficient in collecting its credit sales, while a lower ratio might suggest issues with credit policies or collection efforts.

Accounts receivable (AR) represents the money owed to a company by its customers for goods or services that have been delivered or used but not yet paid for. These are essentially short-term debts owed to the company.

Why is Receivables Turnover Important?

This ratio is vital for several reasons:

1. Cash Flow Management: Efficient collection of receivables directly impacts a company's cash flow. A higher turnover means cash is coming in faster, which can be reinvested or used to cover operational expenses.
2. Liquidity Assessment: It helps assess a company's short-term liquidity. Companies with high turnover are generally more liquid as their assets (receivables) are quickly converted into cash.
3. Credit Policy Evaluation: The ratio can highlight the effectiveness of a company's credit policies. If the turnover is too low, it might indicate that the company is extending credit too liberally or has weak collection procedures.
4. Identifying Potential Issues: A declining receivables turnover ratio could signal problems such as deteriorating customer credit quality, economic downturns affecting customer payments, or internal inefficiencies in the collection department.
5. Comparative Analysis: It allows for comparison with industry averages and competitors, providing a benchmark for performance.

How to Calculate Receivables Turnover

The formula for calculating the receivables turnover ratio is straightforward:

Receivables Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Let's break down each component:

• Net Credit Sales: This refers to the total amount of sales made on credit during a period, minus any sales returns, allowances, or discounts. It's crucial to use only credit sales, not total sales, as cash sales do not generate accounts receivable. If net credit sales are not explicitly available, total net sales are often used as a proxy, though this can slightly skew the accuracy.
• Average Accounts Receivable: Since accounts receivable balances can fluctuate throughout the year, using an average provides a more representative figure. It is calculated as:

  Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2

  The beginning and ending accounts receivable balances are typically taken from the balance sheets at the start and end of the accounting period.

Related Metric: Days Sales Outstanding (DSO)

Closely related to the receivables turnover ratio is the Days Sales Outstanding (DSO), also known as the average collection period. This metric tells you the average number of days it takes for a company to collect its accounts receivable. It's calculated as:

Days Sales Outstanding = 365 / Receivables Turnover Ratio

A lower DSO indicates that a company collects its receivables more quickly, which is generally favorable.

Example Calculation:

Let's say a company has the following financial data for the year:

• Net Credit Sales: $750,000
• Beginning Accounts Receivable: $80,000
• Ending Accounts Receivable: $120,000

First, calculate the Average Accounts Receivable:

Average Accounts Receivable = ($80,000 + $120,000) / 2 = $200,000 / 2 = $100,000

Next, calculate the Receivables Turnover Ratio:

Receivables Turnover Ratio = $750,000 / $100,000 = 7.5 times

Finally, calculate the Days Sales Outstanding:

Days Sales Outstanding = 365 / 7.5 = 48.67 days

This means the company collects its average accounts receivable 7.5 times a year, and on average, it takes about 49 days to collect payment after a sale.

Interpreting the Results

• High Receivables Turnover Ratio: Generally indicates efficient credit management and collection. Customers are paying quickly, which is good for cash flow. However, an extremely high ratio might suggest that the company's credit terms are too strict, potentially deterring sales.
• Low Receivables Turnover Ratio: May signal problems. It could mean the company has lax credit policies, ineffective collection efforts, or that its customers are struggling financially. A low ratio ties up cash in receivables, hindering liquidity.

It's important to compare the ratio against industry benchmarks and the company's historical performance. What's considered "good" can vary significantly between industries. For instance, an industry with typically longer payment terms (e.g., construction) will naturally have a lower turnover ratio than one with shorter terms (e.g., retail).

Using the Calculator

Our Receivables Turnover Calculator simplifies this process for you. Simply input the following figures:

1. Net Credit Sales: The total credit sales for the period.
2. Beginning Accounts Receivable: The accounts receivable balance at the start of the period.
3. Ending Accounts Receivable: The accounts receivable balance at the end of the period.

The calculator will instantly provide you with the Receivables Turnover Ratio and the Days Sales Outstanding, helping you quickly assess your company's credit and collection efficiency.

Conclusion

The receivables turnover ratio is a powerful tool for financial analysis, offering a clear picture of how effectively a company manages its credit sales and collections. By regularly monitoring this ratio and its related metric, Days Sales Outstanding, businesses can make informed decisions to optimize their cash flow, refine credit policies, and improve overall financial health.