Accounts Receivable Turnover Ratio Definition Calculation

The accounts receivable turnover ratio measures how efficiently a company collects money owed to it from customers. It shows how many times a company's average accounts receivable is sold and collected during a period, typically a year.

Definition

The accounts receivable turnover ratio is a liquidity ratio that measures how quickly a company collects money owed to it from customers. It indicates the efficiency of a company's credit and collection policies.

This ratio is calculated by dividing the total credit sales by the average accounts receivable balance during the period. A higher ratio indicates more efficient collection of receivables.

Calculation

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

Where:

Credit Sales - Total sales made on credit during the period
Average Accounts Receivable - 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.

Interpretation

The accounts receivable turnover ratio provides insights into a company's efficiency in collecting payments from customers. Here's how to interpret different values:

Ratio Value	Interpretation
Less than 4	Indicates poor collection efficiency, suggesting potential issues with credit policies or collection processes
4 to 6	Represents moderate collection efficiency, with room for improvement
6 to 8	Indicates good collection efficiency, with effective credit policies and collection processes
Greater than 8	Suggests excellent collection efficiency, with highly effective credit policies and collection processes

Note: Industry benchmarks may vary. For example, manufacturing companies typically have higher ratios than retail companies.

Worked Example

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

Credit Sales: $500,000
Beginning Accounts Receivable: $100,000
Ending Accounts Receivable: $120,000

Step 1: Calculate the average accounts receivable

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

= ($100,000 + $120,000) / 2

= $220,000 / 2

= $110,000

Step 2: Calculate the accounts receivable turnover ratio

Accounts Receivable Turnover Ratio = Credit Sales / Average Accounts Receivable

= $500,000 / $110,000

= 4.545

Interpretation: The company's accounts receivable turnover ratio of 4.545 falls in the moderate collection efficiency range, indicating room for improvement in collection processes.

FAQ

What is a good accounts receivable turnover ratio?: A good accounts receivable turnover ratio varies by industry. Generally, ratios between 6 and 8 are considered good, while ratios above 8 indicate excellent collection efficiency.
How does the accounts receivable turnover ratio differ from the days sales outstanding?: The accounts receivable turnover ratio measures how many times a company collects its average accounts receivable, while the days sales outstanding measures the average number of days it takes to collect receivables.
What factors can affect the accounts receivable turnover ratio?: Factors that can affect the accounts receivable turnover ratio include credit policies, collection processes, industry trends, and economic conditions.
How can a company improve its accounts receivable turnover ratio?: A company can improve its accounts receivable turnover ratio by implementing stricter credit policies, improving collection processes, offering payment incentives, and using technology to streamline collections.
Is the accounts receivable turnover ratio the same as the receivables turnover ratio?: Yes, the accounts receivable turnover ratio and the receivables turnover ratio are the same metric, measuring the efficiency of collecting money owed to a company from customers.