Accounts Receivable Turnover Definition Calculation

Accounts receivable turnover measures how efficiently a company collects payments from its customers. It's a key financial ratio that helps assess a company's credit and collection efficiency. This guide explains the definition, calculation method, and importance of accounts receivable turnover, along with a practical calculator.

Definition

Accounts receivable turnover (ART) is a financial metric that measures how many times a company collects its average accounts receivable during a specific period, typically a year. It indicates how efficiently a company collects payments from its customers.

The ratio is calculated by dividing the total credit sales by the average accounts receivable balance. A higher turnover ratio generally indicates better collection efficiency, while a lower ratio may suggest potential issues with collections or credit policies.

Calculation Method

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

Accounts Receivable Turnover = 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

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

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

For example, if a company had $500,000 in credit sales and an average accounts receivable of $100,000, the accounts receivable turnover would be 5.0.

Importance

Accounts receivable turnover is an important financial metric for several reasons:

Collection Efficiency - A higher turnover ratio indicates that the company is collecting payments more quickly, which can improve cash flow and working capital.
Credit Management - The ratio helps assess how effectively a company is managing its credit policies and extending credit to customers.
Performance Comparison - Companies can compare their accounts receivable turnover with industry averages or competitors to benchmark their performance.
Liquidity Assessment - A higher turnover ratio suggests better liquidity, as the company is able to convert its receivables into cash more quickly.

However, it's important to note that a high turnover ratio doesn't necessarily mean the company is doing well. For example, a company might have a high turnover ratio if it offers very short payment terms to customers, which could indicate pressure on collections.

Worked Example

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

Item	Amount
Beginning Accounts Receivable	$80,000
Ending Accounts Receivable	$120,000
Credit Sales	$600,000

First, calculate the average accounts receivable:

Average Accounts Receivable = ($80,000 + $120,000) / 2 = $100,000

Next, calculate the accounts receivable turnover:

Accounts Receivable Turnover = $600,000 / $100,000 = 6.0

This means the company collects its average accounts receivable 6 times per year. A ratio of 6.0 is generally considered good, indicating efficient collections.

FAQ

What is a good accounts receivable turnover ratio?

A good accounts receivable turnover ratio varies by industry. Generally, ratios above 4.0 are considered good, while ratios below 2.0 may indicate collection issues. Industry averages can serve as a benchmark for comparison.

How does accounts receivable turnover relate to cash flow?

A higher accounts receivable turnover ratio typically indicates better cash flow, as the company is collecting payments more quickly. This can improve working capital and liquidity.

Can accounts receivable turnover be negative?

No, accounts receivable turnover cannot be negative. The ratio is calculated by dividing credit sales by average accounts receivable, which are both positive amounts.

How often should accounts receivable turnover be calculated?

Accounts receivable turnover is typically calculated annually, as it provides a comprehensive view of the company's collection efficiency over a full fiscal year.