How to Calculate Account Receivable Turnover Ratio

The account receivable turnover ratio is a key financial metric that measures how efficiently a company collects payments from its customers. It helps assess the company's ability to manage its accounts receivable and convert them into cash.

What is Account Receivable Turnover Ratio?

The account receivable turnover ratio, also known as the receivables turnover ratio, is a financial metric that measures how many times a company collects its average accounts receivable during a specific period. A higher ratio indicates that the company is more efficient at collecting payments from its customers.

This ratio is particularly important for businesses that rely on credit sales. It helps management understand how quickly they can turn their receivables into cash, which is crucial for maintaining liquidity and financial health.

How to Calculate It

Calculating the account receivable turnover ratio involves a straightforward formula. You'll need two key pieces of information:

The total credit sales (or net credit sales) for the period
The average accounts receivable balance during the period

Once you have these figures, you can plug them into the formula to get the ratio. The result will tell you how many times your company collects its average receivables during the period.

The Formula

Account Receivable Turnover Ratio = Total Credit Sales / Average Accounts Receivable

Where:

Total 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.

Interpreting the Ratio

The account receivable turnover ratio is typically expressed as a number of times. For example, a ratio of 5 means the company collects its average receivables 5 times during the period.

Industry benchmarks can help you interpret the ratio:

Manufacturing: Typically 4-8 times
Retail: Typically 6-12 times
Wholesale: Typically 3-6 times

A higher ratio is generally better, as it indicates that the company is more efficient at collecting payments. However, the ideal ratio can vary depending on the industry and the company's specific circumstances.

Worked Example

Let's walk through a practical example to see how the account receivable turnover ratio is calculated.

Example Scenario

Company XYZ has the following financial data for the past year:

Total credit sales: $500,000
Beginning accounts receivable: $80,000
Ending accounts receivable: $120,000

Step 1: Calculate Average Accounts Receivable

Average accounts receivable = (Beginning accounts receivable + Ending accounts receivable) / 2

Average accounts receivable = ($80,000 + $120,000) / 2 = $100,000

Step 2: Apply the Formula

Account receivable turnover ratio = Total credit sales / Average accounts receivable

Account receivable turnover ratio = $500,000 / $100,000 = 5

Interpretation

The ratio of 5 means that Company XYZ collects its average receivables 5 times during the year. This is a good result, indicating that the company is efficient at collecting payments from its customers.

FAQ

What is a good account receivable turnover ratio?

A good account receivable turnover ratio varies by industry. Generally, ratios between 4 and 12 times are considered good, with higher ratios indicating more efficient collection.

How does the account receivable turnover ratio differ from the days sales outstanding?

The account receivable turnover ratio measures how many times a company collects its receivables, while the days sales outstanding measures the average number of days it takes to collect payments. Both metrics provide insights into a company's credit collection efficiency.

Can the account receivable turnover ratio be negative?

No, the account receivable turnover ratio cannot be negative. It's calculated by dividing total credit sales by average accounts receivable, which are both positive amounts. A negative ratio would indicate an error in the calculation or data.