How Is Accounts Receivable Turnover Calculated

Accounts receivable turnover is a key financial metric that 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 turnover ratio indicates better cash flow management and collection efficiency.

What is Accounts Receivable Turnover?

Accounts receivable turnover is a financial ratio that measures 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 metric helps assess a company's efficiency in collecting payments and managing its working capital.

Accounts receivable turnover is different from days sales outstanding (DSO), which measures the average number of days it takes to collect payments. While both metrics are useful, turnover provides a more direct comparison between companies of different sizes.

How to Calculate Accounts Receivable Turnover

The formula for accounts receivable turnover is straightforward:

Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

Where:

Net 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 AR + Ending AR) / 2

Interpreting Accounts Receivable Turnover

The accounts receivable turnover ratio is typically expressed as a number of times per year. Industry benchmarks vary by sector, but generally:

Turnover ratios below 4 are considered poor
Turnover ratios between 4 and 6 are average
Turnover ratios above 6 are considered good

A higher turnover ratio indicates that a company is more efficient at collecting payments, which can improve cash flow and working capital management. However, a very high turnover ratio might indicate aggressive collection practices or overly optimistic sales projections.

While a high turnover ratio is generally positive, it's important to consider other financial metrics and the company's overall financial health. A company with excellent collection efficiency but poor sales growth might still face challenges.

Worked Example

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

Metric	Value
Beginning Accounts Receivable	$50,000
Ending Accounts Receivable	$70,000
Net Credit Sales	$600,000

First, calculate the average accounts receivable:

Average Accounts Receivable = ($50,000 + $70,000) / 2 = $60,000

Then, calculate the accounts receivable turnover:

Accounts Receivable Turnover = $600,000 / $60,000 = 10 times

This result of 10 times indicates excellent collection efficiency for this company.

FAQ

What is a good accounts receivable turnover ratio?

A good accounts receivable turnover ratio varies by industry. Generally, ratios above 6 are considered good, while those below 4 are poor. However, the ideal ratio depends on the company's specific circumstances and industry standards.

How does accounts receivable turnover relate to cash flow?

A higher accounts receivable turnover ratio typically indicates better cash flow because it means the company collects payments more quickly. This can improve liquidity and working capital management, which are crucial for a company's financial health.

What factors can affect accounts receivable turnover?

Several factors can affect accounts receivable turnover, including credit policies, payment terms, industry trends, and the company's collection practices. Companies with strict credit policies or those in industries with slower payment cycles may have lower turnover ratios.

How does accounts receivable turnover compare to days sales outstanding?

Accounts receivable turnover and days sales outstanding (DSO) are related but measure different aspects of the same process. Turnover is a ratio that shows how many times accounts receivable is collected in a period, while DSO measures the average number of days it takes to collect payments. Both metrics are useful but provide different insights into a company's collection efficiency.