The formula for calculating the AR turnover rate for a one-year period looks like this: Average accounts receivables is calculated as the sum of starting and ending receivables over a set period of time (generally monthly, quarterly or annually), divided by two. Net sales is calculated as sales on credit - sales returns - sales allowances. It measures how efficiently and quickly a company converts its account receivables into cash within a given accounting period.Īccounts Receivable (AR) Turnover Ratio Formula & Calculation: The AR Turnover Ratio is calculated by dividing net sales by average account receivables. How to Calculate Accounts Receivable (AR) Turnover RatioĪlso known as the “receivable turnover” or “debtors turnover” ratio, the accounts receivable turnover ratio is an efficiency ratio - specifically an activity financial ratio - used in financial statement analysis. You can improve your ratio by being more effective in your billing efforts and improving your cash flow (opens in a new tab).As noted above business type and industry can impact your AR ratio so the score viewed on its own may not reflect the quality of your customer base or effectiveness of your retention efforts - it needs to be viewed in context.So it is good practice to compare yourself with others in your industry. Turnover ratio needs to be taken in context with the business type - companies with high a AR turnover are a result of the processes in place to secure payment - for example retail, grocery stores, etc.In some cases, the business owner may offer terms that are too generous or may be at the mercy of companies that require a longer than 30 day payment cycle. While a low AR turnover ratio won’t score points with lenders, it doesn’t always indicate risky customers.A high AR turnover ratio is usually desirable, but not if credit policies are too restrictive and negatively impact sales.In both cases, the accounts receivable turnover ratio shows how long it takes customers to pay, on average, and that information in turn reveals a lot about how financially stable the company is and how well its cash flow is managed. In other words, its accounts receivables are better protected as service can be disconnected before further credit is extended to the customer. All customers are billed a month in advance of service delivery, thereby preventing any customer from receiving services without paying the bill. A few may go out of business and not pay Joe’s Bait Company anything at all.īy comparison, LookeeLou Cable TV company delivers cable TV, internet and VoIP phone service to consumers. Some of the company’s customers pay on time as agreed, but some pay late. Payment terms are the same for each customer: net30, meaning payment is due thirty days after the invoice date. The company invoices each of the stores once a month. The accounts receivable turnover ratio is used in business accounting to quantify how well companies are managing the credit that they extend to their customers by evaluating how long it takes to collect the outstanding debt throughout the accounting period.įor example, Joe’s Bait Company supplies fish bait to stores at docks and marinas throughout the Southeast. What Is Accounts Receivable (AR) Turnover Ratio? If money is not coming in from customers as agreed and expected, cash flow can dry to a trickle.Ĭonversely, when collections are managed efficiently, the business’ cash flow becomes more predictable, collection costs are lower and its balance sheet is healthier, which is a very important factor when a company seeks to obtain credit, invest in growth and attract investors. Source: Harvey A.The accounts receivable turnover ratio is one metric to watch closely as it measures how effectively a company is handling collections. You should be well prepared to discuss their meaning. As your business becomes more sophisticated and your statements become more complex, ask your accountant for help. These analyses are intended to help you understand financial state-ments. In effect, the company is borrowing from its suppliers to expand its working capital. You can see that the company is paying its bills more slowly than it is collecting its accounts receivable. If you look at the accounts receivable turnoverâ��the example indicates forty daysâ��compare this to the accounts payable turnover, which is every forty-three days. As our example is one year, we will use 360 days, thus indicating that the accounts payable are being paid every forty-three days. To determine the number of days a business will take to pay its bills, divide the amount indicated, 8.4, into the number of days in the accounting period. The Accounts Payable Turnover indicates the number of times accounts payable will be paid during the year.
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