How to Calculate the Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio (AR turnover ratio) is a bookkeeping metric that business owners use to compare total sales revenue to actual customer payments. When properly calculated over the course of an accounting period, an AR turnover ratio can show companies the average number of days their payment collections process takes.

Companies measure AR turnover ratios because not all customers pay their bills on time. As a general rule, high-quality customers quickly pay invoices sent by an accounts receivable department. Other members of a customer base may be less reliable and not pay their bills for weeks or even months after invoicing. By monitoring an AR turnover ratio from one accounting period to the next, companies can predict how much working capital they’ll have on hand and help shield themselves from bad debt.

To calculate the accounts receivable turnover ratio, you must first collect several inputs from financial statements.

1. 1. Find the net credit sales. This represents goods and services sold on credit with the final payments collected at a later date.
2. 2. Calculate the average accounts receivable. This metric can be found by adding the beginning accounts receivable balance for a given period of time to the ending accounts receivable balance for that same period of time and then dividing the sum by two. This will give you an average accounts receivable balance within the measured time period.
3. 3. Plug the inputs into the AR turnover ratio formula. Once you have these two inputs, you plug them into the accounts receivable turnover ratio formula: Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable.

Once you have calculated your company's accounts receivable turnover ratio, you can use that ratio to evaluate your company's collection times, credit policies, and overall accounting practices.

• Collection times: To calculate your company's average collection period, take your AR turnover ratio number and divide it into the number of days in an accounting period. For instance, if your business had a ratio of 6.6 over the course of a year, that means it collects its average accounts receivable balance 6.6 times over the course of the fiscal year. You can then divide 365 (the number of days in a year) by 6.6 to get a quotient of 55.3. This means it takes an average of 55.3 days for the company's average customer to settle up late payments to the company.
• Credit policies: An accounts receivable turnover ratio measures how long it takes for customers to pay their bills. This turnover rate offers a window into your company's payment terms. A high ratio means customers pay you back in a reasonable period of time and you can expect steady cash flow. A lower efficiency ratio means you may need to adopt a more conservative credit policy. A small business, in particular, cannot be saddled with too many unpaid bills as this may impact the end-of-the-year income statements and scare off potential lenders and investors.
• Accounting policies: Standard accounting software lets a company maintain its books on either a cash basis or an accrual basis. Cash basis bookkeeping is simpler, but it is only possible if invoices from accounts receivable are paid quickly. If you have a low accounts receivable turnover ratio (and your debtor's turnover ratio is high), you may consider bookkeeping on an accrual basis. On the other hand, if your business overwhelmingly relies on cash sales (such as in the restaurant industry), bookkeeping on a cash basis may be preferable.

The accounts receivable turnover ratio and the asset turnover ratio are both financial ratios that help measure a company's financial health. While the accounts receivable turnover ratio focuses on collecting unpaid fees from customers, the assets turnover ratio compares a company's sales volume to the average value of its assets.

• Asset turnover ratio: Calculate the asset turnover ratio using this formula: Asset Turnover = Total Sales Revenue / Average Annual Asset Value.
• Accounts receivable turnover ratio: Calculate the accounts receivable turnover ratio using this formula: Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable.

You can find a company's average annual asset value by adding its total asset value at the beginning of the year to its total asset value at the end of the year and then dividing that sum by two. Healthy asset turnover ratios vary from one industry to another. For instance, retail businesses quickly churn through products, so their sales totals tend to be much higher than their average annual asset values. By contrast, a public utility, which may own large pieces of infrastructure like a power grid, tends to have far higher asset values than sales revenue.

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