The Accounts Receivable Turnover ratio is a crucial financial metric that measures how efficiently a company collects its outstanding debts (accounts receivable). It indicates how many times a company can turn its receivables into cash during a specific period, typically a fiscal year. A higher turnover ratio generally suggests that a company is collecting its debts quickly and effectively, while a lower ratio might indicate issues with credit policies, collection efficiency, or the quality of receivables.
The Formula
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
Let's break down the components:
Net Credit Sales: This represents the total sales made on credit during a period, minus any sales returns, allowances, or discounts. It's important to use credit sales because these are the sales that generate accounts receivable. If credit sales data isn't readily available, total sales are sometimes used as a proxy, but this can be less accurate.
Average Accounts Receivable: This is calculated by summing the accounts receivable balance at the beginning of the period and the accounts receivable balance at the end of the period, then dividing by two.
Monitoring the Accounts Receivable Turnover ratio helps businesses in several ways:
Assessing Collection Efficiency: It provides insight into how well the company's credit and collection departments are performing.
Identifying Potential Problems: A declining turnover ratio might signal that customers are taking longer to pay, potentially indicating financial distress among customers or issues with the company's collection process.
Benchmarking: The ratio can be compared against industry averages to understand how the company performs relative to its peers.
Cash Flow Management: A healthy turnover ratio contributes to better cash flow, as money owed by customers is converted into usable cash more rapidly.
Interpreting the Results
The "ideal" Accounts Receivable Turnover Ratio varies significantly by industry. For instance, companies with fast-moving consumer goods might have much higher ratios than businesses in industries with longer sales cycles or more complex payment terms.
A very high ratio might suggest that credit terms are too strict, potentially deterring sales. Conversely, a very low ratio indicates slow collections, which ties up working capital and increases the risk of bad debts.
Example Calculation
Suppose a company reports the following for a fiscal year:
Net Credit Sales: $600,000
Accounts Receivable at the beginning of the year: $45,000
Accounts Receivable at the end of the year: $55,000
Now, calculate the Accounts Receivable Turnover Ratio:
Accounts Receivable Turnover Ratio = $600,000 / $50,000 = 12
This result means the company collected its average accounts receivable 12 times during the year. This ratio can then be used to calculate the Average Collection Period (Days Sales Outstanding) by dividing the number of days in the period (e.g., 365) by the turnover ratio. In this example, 365 / 12 ≈ 30.4 days, indicating the company collects its receivables, on average, every 30.4 days.
function calculateARTurnover() {
var netCreditSalesInput = document.getElementById("netCreditSales");
var averageAccountsReceivableInput = document.getElementById("averageAccountsReceivable");
var resultValueDiv = document.getElementById("result-value");
var netCreditSales = parseFloat(netCreditSalesInput.value);
var averageAccountsReceivable = parseFloat(averageAccountsReceivableInput.value);
if (isNaN(netCreditSales) || isNaN(averageAccountsReceivable)) {
resultValueDiv.innerHTML = "Invalid input";
return;
}
if (averageAccountsReceivable === 0) {
resultValueDiv.innerHTML = "AR cannot be zero";
return;
}
var turnoverRatio = netCreditSales / averageAccountsReceivable;
// Format the output to two decimal places
resultValueDiv.innerHTML = turnoverRatio.toFixed(2);
}