How to Calculate The Accounts Receivable Turnover Ratio

The Accounts Receivable Turnover Ratio 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 ratio indicates better collection efficiency.

What is the Accounts Receivable Turnover Ratio?

The Accounts Receivable Turnover Ratio is a financial metric that evaluates how quickly a company collects money owed to it from customers. It's calculated by dividing the total credit sales (or net credit sales) by the average accounts receivable balance during the period.

Key Points

Measures collection efficiency
Indicates how many times receivables are collected per year
Higher ratios generally indicate better cash flow management

This ratio is particularly important for businesses that rely on credit sales. It helps assess whether a company is effectively managing its receivables and whether it needs to improve its collection processes or credit policies.

How to Calculate the Accounts Receivable Turnover Ratio

The formula for calculating the Accounts Receivable Turnover Ratio is straightforward:

Formula

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Where:

Net Credit Sales - Total sales on credit during the period
Average Accounts Receivable - The average balance of accounts receivable during the period

To calculate the average accounts receivable, you can use the following formula:

Average Accounts Receivable Formula

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

This ratio is typically expressed as a number of times per year. A ratio of 4 means the company collects its receivables 4 times during the year.

Interpreting the Accounts Receivable Turnover Ratio

The interpretation of the Accounts Receivable Turnover Ratio depends on the industry and company size. Generally:

Excellent - Above 8 times per year
Good - 6 to 8 times per year
Average - 4 to 6 times per year
Poor - Below 4 times per year

A high ratio indicates that the company is collecting payments quickly, which can improve cash flow and working capital. A low ratio may indicate problems with collection processes or that the company is extending credit terms too liberally.

Industry Considerations

Industry benchmarks vary. For example, retail companies might have different expectations than manufacturing companies. Always compare your ratio to industry standards.

Worked Example

Let's calculate the Accounts Receivable Turnover Ratio for a company with the following data:

Metric	Value
Net Credit Sales	$500,000
Beginning Accounts Receivable	$100,000
Ending Accounts Receivable	$80,000

First, calculate the average accounts receivable:

Average Accounts Receivable Calculation

Average Accounts Receivable = ($100,000 + $80,000) / 2 = $90,000

Now, calculate the turnover ratio:

Accounts Receivable Turnover Ratio Calculation

Accounts Receivable Turnover Ratio = $500,000 / $90,000 ≈ 5.56

This means the company collects its receivables approximately 5.56 times per year, which is considered good.

Frequently Asked Questions

What is a good Accounts Receivable Turnover Ratio?: A good ratio varies by industry, but generally above 6 times per year is considered good, and above 8 is excellent.
How does the Accounts Receivable Turnover Ratio relate to cash flow?: A higher ratio indicates better cash flow management as it shows the company is collecting payments more quickly.
What factors can improve the Accounts Receivable Turnover Ratio?: Improving collection processes, offering discounts for early payment, and maintaining good customer relationships can help.
Is the Accounts Receivable Turnover Ratio the same as the Days Sales Outstanding?: No, they are related but measure different aspects. The turnover ratio measures how many times receivables are collected, while Days Sales Outstanding measures the average number of days it takes to collect payments.
How often should I calculate the Accounts Receivable Turnover Ratio?: It's typically calculated annually, but quarterly calculations can provide more insight into trends and changes in collection efficiency.