How to Calculate Account Receivable Turnover

Account 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 during a period, typically a year. A higher turnover ratio indicates better cash flow management and customer payment habits.

What is Account Receivable Turnover?

Account receivable turnover (also called accounts receivable turnover ratio) is a liquidity ratio that measures how quickly a company collects money from its customers. It's calculated by dividing the total credit sales by the average accounts receivable balance during the period.

This metric is important because it provides insight into a company's credit collection efficiency and cash flow management. A higher turnover ratio generally indicates that the company is more effective at collecting payments from its customers, which can lead to better liquidity and financial health.

Key Point: Account receivable turnover is different from days sales outstanding (DSO), which measures the average number of days it takes to collect payments from customers.

How to Calculate Account Receivable Turnover

Calculating account receivable turnover involves a few straightforward steps:

Determine your total credit sales for the period (typically a year).
Calculate your average accounts receivable balance during the same period.
Divide the total credit sales by the average accounts receivable balance.

The result is your account receivable turnover ratio, which you can compare to industry benchmarks or your company's historical performance.

Formula: Account Receivable Turnover = Total Credit Sales / Average Accounts Receivable

The Formula

The account receivable turnover formula is:

Account Receivable Turnover = 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, calculated by adding the beginning and ending accounts receivable balances and dividing by 2.

Note: Some companies use the ending accounts receivable balance instead of the average, but the average provides a more accurate picture of the company's credit collection efficiency over the period.

Worked Example

Let's look at an example to see how account receivable turnover is calculated.

Item	Amount
Beginning Accounts Receivable	$50,000
Ending Accounts Receivable	$30,000
Total Credit Sales	$500,000

First, calculate the average accounts receivable:

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

= ($50,000 + $30,000) / 2

= $80,000 / 2

= $40,000

Next, calculate the account receivable turnover:

Account Receivable Turnover = Total Credit Sales / Average Accounts Receivable

= $500,000 / $40,000

= 12.5

This means the company collected payments 12.5 times during the period, indicating good credit collection efficiency.

Interpreting the Result

Interpreting account receivable turnover requires comparing the result to industry benchmarks and considering your company's specific circumstances. Here are some general guidelines:

High Turnover (10+) - Indicates excellent credit collection efficiency and strong customer payment habits.
Moderate Turnover (5-9) - Shows average credit collection performance that may need improvement.
Low Turnover (Below 5) - Suggests poor credit collection efficiency and may indicate problems with customer payment habits or collection processes.

Industry Comparison: The average account receivable turnover for most industries is between 5 and 10. Companies in industries with longer payment terms may have lower turnover ratios.

It's important to consider other factors when interpreting the result, such as the company's credit policies, customer payment habits, and industry standards. A high turnover ratio may indicate strong credit collection, but it could also reflect aggressive collection practices or a high risk of bad debts.

FAQ

What is a good account receivable turnover ratio?: A good account receivable turnover ratio varies by industry. Generally, ratios above 10 indicate excellent performance, while ratios below 5 suggest poor credit collection efficiency.
How does account receivable turnover relate to days sales outstanding?: Account receivable turnover and days sales outstanding (DSO) are related metrics. DSO measures the average number of days it takes to collect payments, while turnover measures how many times the company collects its average accounts receivable. The two metrics are inversely related.
What factors can affect account receivable turnover?: Several factors can affect account receivable turnover, including credit policies, customer payment habits, industry standards, and the company's collection processes. Economic conditions and changes in customer behavior can also impact the ratio.
How often should account receivable turnover be calculated?: Account receivable turnover is typically calculated annually, but it can also be calculated quarterly or monthly to monitor trends and identify issues with credit collection.
What are the limitations of account receivable turnover?: Account receivable turnover has some limitations. It doesn't account for the quality of receivables or the risk of bad debts. It also doesn't consider the timing of payments, which can affect cash flow.