Account Receivable Calculation Turnover Ratio

The Account 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 during a period, typically a year.

What is Account Receivable Turnover Ratio?

The Account Receivable Turnover Ratio is a financial metric that indicates how quickly a company collects money owed to it from customers. It's calculated by dividing the total credit sales by the average accounts receivable balance during the period.

This ratio helps businesses assess their efficiency in collecting payments and managing their working capital. A higher ratio generally indicates better collection efficiency, while a lower ratio may suggest delays in payment collection.

Key Point: The Account Receivable Turnover Ratio is different from the Days Sales Outstanding (DSO) metric, which measures the average number of days it takes to collect payments.

How to Calculate the Account Receivable Turnover Ratio

The formula for calculating the Account Receivable Turnover Ratio is:

Account Receivable Turnover Ratio = Credit Sales / Average Accounts Receivable

Where:

Credit Sales - Total sales made on credit during the period
Average Accounts Receivable - The average balance of accounts receivable during the period

To calculate the average accounts receivable, you can use the following formula:

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

This ratio is typically expressed as a number without a unit, showing how many times the company collects its receivables in a year.

Interpreting the Account Receivable Turnover Ratio

The Account Receivable Turnover Ratio is considered good when it's higher than industry averages for your sector. Generally:

Ratios above 6-8 are excellent
Ratios between 4-6 are average
Ratios below 4 indicate potential collection problems

A high ratio suggests efficient collection processes, while a low ratio may indicate delays in payment collection or excessive credit terms.

Industry Comparison: Manufacturing companies typically have higher ratios than retail businesses due to different payment practices.

Worked Example

Let's calculate the Account Receivable Turnover Ratio for a company with the following data:

Metric	Value
Beginning Accounts Receivable	$50,000
Ending Accounts Receivable	$60,000
Credit Sales	$300,000

First, calculate the average accounts receivable:

Average Accounts Receivable = ($50,000 + $60,000) / 2 = $55,000

Then, calculate the turnover ratio:

Account Receivable Turnover Ratio = $300,000 / $55,000 ≈ 5.45

This ratio of 5.45 indicates that the company collects its average accounts receivable about 5.45 times per year, which is average for most industries.

FAQ

What is a good Account Receivable Turnover Ratio?

A good ratio varies by industry. Typically, ratios above 6-8 are excellent, while ratios below 4 may indicate collection problems.

How does the Account Receivable Turnover Ratio differ from Days Sales Outstanding?

The Turnover Ratio shows how many times receivables are collected in a year, while Days Sales Outstanding measures the average number of days it takes to collect payments.

What factors can affect the Account Receivable Turnover Ratio?

Factors include credit terms offered to customers, collection policies, industry payment practices, and economic conditions.

Is a higher Account Receivable Turnover Ratio always better?

While generally better, extremely high ratios might indicate aggressive collection practices or overly lenient credit terms.