9 How Do You Calculate The Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio measures how efficiently a company collects payments from its customers. It shows how many times a company collects its average accounts receivable balance during a period, typically a year. A higher ratio indicates better cash flow management and collection efficiency.

What is Accounts Receivable Turnover?

The accounts receivable turnover ratio is a key financial metric that measures how quickly a company collects payments from its customers. It provides insight into the efficiency of a company's credit and collections process.

This ratio is particularly important for businesses that rely on credit sales. It helps assess whether a company is effectively managing its cash flow by collecting payments promptly from customers.

Accounts receivable refers to the money owed to a company by its customers for goods or services provided on credit. It represents the company's short-term assets that are expected to be collected within one year.

How to Calculate the Accounts Receivable Turnover Ratio

Calculating the accounts receivable turnover ratio involves two main steps:

Determine the net credit sales for the period (typically a year)
Divide this by the average accounts receivable balance during the same period

The result is the number of times the company collects its average accounts receivable balance during the period.

Formula: Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

The Formula

The accounts receivable turnover ratio is calculated using the following formula:

Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

Where:

Net Credit Sales - The total amount of goods or services sold on credit during the period
Average Accounts Receivable - The average balance of accounts receivable during the period

The average accounts receivable is calculated by adding the beginning and ending accounts receivable balances and dividing by 2.

Worked Example

Let's calculate the accounts receivable turnover ratio for a company with the following data:

Item	Amount ($)
Beginning Accounts Receivable	$50,000
Ending Accounts Receivable	$60,000
Net Credit Sales	$500,000

Step 1: Calculate the average accounts receivable

Average Accounts Receivable = (Beginning AR + Ending AR) / 2

= ($50,000 + $60,000) / 2

= $55,000

Step 2: Calculate the accounts receivable turnover ratio

Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

= $500,000 / $55,000

= 9.09

The company's accounts receivable turnover ratio is 9.09, meaning it collects its average accounts receivable balance 9.09 times per year.

Interpreting the Result

The accounts receivable turnover ratio provides several insights about a company's financial health:

Efficiency of Collections: A higher ratio indicates that the company is collecting payments more quickly, which is generally favorable.
Cash Flow Management: A good ratio suggests that the company is managing its cash flow effectively by collecting payments promptly.
Credit Policy: The ratio can reflect the company's credit policy - a higher ratio might indicate a more aggressive approach to collections.

Industry benchmarks can provide context for interpreting the ratio. For example, in the retail industry, a ratio of 6-8 might be considered good, while in manufacturing, ratios of 4-6 might be more typical.

While a higher ratio is generally better, companies should consider other factors when interpreting this metric. For example, a company with a very high ratio might be aggressively pursuing collections, which could lead to higher bad debt expenses.

Frequently Asked Questions

What is a good accounts receivable turnover ratio?: A good ratio varies by industry. Generally, ratios above 6 are considered good, while ratios below 4 may indicate inefficiencies in collections.
How does accounts receivable turnover relate to cash flow?: A higher turnover ratio indicates that a company is collecting payments more quickly, which can improve cash flow. However, it's important to balance this with other financial metrics to get a complete picture.
What factors can affect the accounts receivable turnover ratio?: Several factors can affect the ratio, including the company's credit policy, industry trends, economic conditions, and the effectiveness of collections efforts.
How often should the accounts receivable turnover ratio be calculated?: This ratio is typically calculated annually, but quarterly calculations can provide more insight into a company's collections performance over time.
What is the difference between accounts receivable turnover and days sales outstanding?: While both metrics measure collections efficiency, the turnover ratio shows how many times accounts receivable is collected in a period, while days sales outstanding shows the average number of days it takes to collect payments.