The accounts receivable turnover ratio is an effective measure of your company’s liquidity. It measures the amount of credit you extend and how quickly you collect on those debts. The calculation typically is reserved as an annual touchstone for your business, comparing collections to the previous year’s success rate. Accounts receivable turnover ratio also is referred to as the sales-to-receivable ratio or debtors turnover ratio.
To calculate your accounts receivable turnover rate, only include credit sales. Cash sales can skew the numbers and give you a false sense of your company’s credit and collection abilities. Use a formula that divides your total credit sales by the average accounts receivable balance to reach your accounts receivable turnover ratio. For example, if you had $100,000 in credit sales with an average credit balance of $20,000, your accounts receivable turnover ratio is 5 times.
Usually, your company is in a favorable position when you post higher accounts receivable turnover ratios. At the same time, a turnover ratio that is much higher than is normal for your industry may require a look at your credit policies. While a very high accounts receivable turnover ratio indicates strong collection practices that cause you to carry very little debt, strict credit restrictions may be causing you to lose potential sales. Low accounts receivable turnover ratios may indicate that you’re being too generous with your credit and are having trouble collecting your debts. Alternatively, a low receivables ratio may indicate that your collection practices are not working or your collections department needs corrective action.
A liberal credit policy can help you increase sales. When coupled with efficient collection practices, that debt can be expected to turn into cash quickly as it is counted as assets on your income statement. Keeping up with your accounts receivable turnover ratio helps you see how effective your credit policies are and can point you to areas of opportunity. The quality of your debtors can determine the success of your business.
It’s difficult to compare your company’s accounts receivable turnover ratio to another company’s figures, according to financial analysts at MY SMP. So many variables enter the picture and can include credit policies, industry averages and your performance relative to previous years. Every industry posts different acceptable debtor turnover ratios against which you want to build your own strategies. For example, the average accounts receivable ratio for the wholesale pharmacy industry is 15, so if you post a ratio of 19, you are doing better than most. If you calculate a 25 ratio for your collections, your credit and collection practices may need tweaking.
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