Accounts Receivable Turnover Ratio
The Accounts Receivable Turnover Ratio is a financial ratio that measures how efficiently a company is managing its accounts receivable. It is commonly used by companies to analyze the efficiency with which their credit policies and procedures are being implemented.
This ratio essentially measures the frequency with which a company collects payments from customers on their outstanding debts, showing how many times a company collects its average accounts receivable balance during a period. The higher the AR Turnover Ratio, the better position a company is in to collect its owed funds in a timely manner.
How To Calculate Accounts Receivable (AR) Turnover Ratio?
The formula for the Accounts Receivable Turnover Ratio is:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
Net Credit Sales refers to the total amount of credit sales made during a period, excluding any sales made on cash.
Average Accounts Receivable is the average balance of accounts receivable during a period, which is calculated by adding the beginning and ending accounts receivable balances and dividing the sum by two.
A high AR Turnover Ratio indicates that a company is effectively collecting payments from customers and is therefore managing its cash flow well. Conversely, a low AR Turnover Ratio suggests that a company may be experiencing difficulties in collecting payments from its customer base, which may lead to issues with cash flow and financial stability.
Why Is Accounts Receivable Turnover Ratio Important?
The accounts receivable turnover ratio is an essential metric for any business that sells on credit. It measures how quickly a company can collect its outstanding customer debt.
One significant benefit of monitoring AR turnover is its ability to forecast cash inflows. By identifying trends in the ratio over time, a company can predict expected cash collections and, in turn, make informed decisions regarding working capital and short-term borrowing requirements. A high AR turnover ratio can also signal to investors that the company is financially healthy and has strong management in place.
An additional value of tracking AR turnover is that it can serve as an indicator of customer satisfaction. If a company sees a decline in its turnover ratio, it could mean that customers are unsatisfied with the product or service offered by the company, resulting in slower payments or even defaults.
The ideal AR Turnover Ratio can vary across different industries and companies. For example, a company in an industry with shorter payment terms may have a higher AR turnover ratio than a company in an industry with longer payment terms. Additionally, different companies may have different credit policies and payment procedures, which can affect their ability to collect outstanding debts.