How Do You Calculate the Accounts Receivable Turnover

Accounts Receivable Turnover Calculator

Calculation Results:

Average Accounts Receivable:

Accounts Receivable Turnover:

Days Sales Outstanding (DSO):

Understanding the Accounts Receivable Turnover Ratio

The Accounts Receivable Turnover Ratio is a crucial financial metric that measures how efficiently a company collects its credit sales. It indicates how many times, on average, a company collects its accounts receivable during a specific period, typically a year. A higher turnover ratio generally suggests that a company is effective in managing its credit and collecting payments from customers, while a lower ratio might signal potential issues with credit policies or collection efforts.

Why is Accounts Receivable Turnover Important?

This ratio provides valuable insights into a company's liquidity and operational efficiency:

• Liquidity Management: A high turnover means cash is flowing into the business more quickly, improving liquidity and reducing the need for external financing.
• Credit Policy Effectiveness: It helps assess if the company's credit terms are too lenient or too strict.
• Collection Efficiency: A declining ratio could indicate problems with the collection department or an increase in bad debts.
• Working Capital Optimization: Efficient collection of receivables frees up working capital that can be reinvested in the business.
• Comparative Analysis: It allows comparison with industry benchmarks and competitors to gauge relative performance.

How to Calculate Accounts Receivable Turnover

The formula for calculating the Accounts Receivable Turnover Ratio is:

Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

Let's break down the components:

• Net Credit Sales: This refers to the total sales made on credit during the period, minus any sales returns, allowances, or discounts. It's important to use only credit sales, as cash sales do not generate accounts receivable. If credit sales data is not readily available, total sales might be used as a proxy, but this can distort the accuracy of the ratio.
• Average Accounts Receivable: This is the average balance of accounts receivable over the period. It is calculated by adding the beginning accounts receivable balance to the ending accounts receivable balance and dividing by two.
  Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2

Interpreting the Results

The Accounts Receivable Turnover Ratio is expressed as a number of "times" per period. For example, a turnover of 8 times means the company collected its average accounts receivable 8 times during the year.

• High Turnover: Generally favorable, indicating efficient credit management and quick collection of payments. However, an excessively high turnover might suggest overly strict credit policies that could deter potential customers.
• Low Turnover: May indicate problems such as inefficient collection processes, lenient credit terms, or a high number of uncollectible accounts (bad debts). It could also signal that customers are taking too long to pay.

Another related and useful metric is the Days Sales Outstanding (DSO), also known as the average collection period. This tells you the average number of days it takes for a company to collect its accounts receivable.

Days Sales Outstanding = 365 / Accounts Receivable Turnover Ratio

A lower DSO is generally better, as it means the company is collecting cash more quickly.

Example Calculation

Let's consider a company with the following financial data for the year:

• Net Credit Sales: $1,500,000
• Beginning Accounts Receivable: $120,000
• Ending Accounts Receivable: $130,000

First, calculate the Average Accounts Receivable:

Average Accounts Receivable = ($120,000 + $130,000) / 2 = $250,000 / 2 = $125,000

Next, calculate the Accounts Receivable Turnover Ratio:

Accounts Receivable Turnover = $1,500,000 / $125,000 = 12 times

Finally, calculate the Days Sales Outstanding:

Days Sales Outstanding = 365 / 12 = 30.42 days

This means the company collects its average accounts receivable 12 times a year, and on average, it takes about 30 days to collect payment from its customers. This would generally be considered a healthy turnover, especially if the company's credit terms are 30 days.