Accounts receivables (A/R) are an ongoing process of improvement, and like all improvements, companies need metrics to monitor their progress. One key metric for measuring A/R efficiency is your accounts receivable turnover ratio. Let’s look at this indicator in more detail.
What Is Accounts Receivable Turnover Ratio?
Essentially, the accounts receivable turnover ratio tells you how well you collect money from clients. The higher the number, the better your company likely is at collecting outstanding balances. Looking at it another way, it’s a measure of how well a company manages the credit it extends to its clients.
How Is A/R Turnover Ratio Calculated?
Here’s the accounts receivable turnover ratio formula for your calculations:
Net Annual Credit Sales / ([Beginning Accounts Receivable + Ending Accounts Receivable] / 2)
To fill in the blanks, take your net value of credit sales in a given time period and divide by the average accounts receivable during that same period. You can get an average for accounts receivables by adding your A/R value at the beginning of the accounting period to the value at the end of that period, then dividing it in half.
Here’s an example of an A/R turnover ratio calculation:
$6,000,000 Net Credit Sales / ($760,000 Beginning Receivables + $850,000 Ending Receivables) / 2
$6,000,000 Net Credit Sales / $805,000
= 7.4 Accounts Receivable Turnover
Knowing how to calculate accounts receivable turnover ratio is the first step, but what does it mean for your financial well-being?
What Is a Good A/R Turnover Ratio?
There are no benchmarks for a “good” turnover ratio because an accounts receivable turnover ratio analysis is industry- and company-specific. Your best bet is to check your metrics regularly (ideally on a monthly basis) and compare your own benchmarks over time.
Measure your ratio each month and review how it changes. Note any fluctuations or spikes in the data and how those changes correlate with improvements to your A/R processes. To get further insight into your finances, examine how many days it takes to collect receivables by dividing your turnover ratio by 365.
With the data above, here’s how this would look:
365 days /7.4 = 49.3 days to collect
This data can be reviewed in context with your other A/R metrics, or it can be assessed on its own. For example, if your company has a 50-day window for customers to make payments, this formula shows you that, on average, client payments are within your policy.
In general, high turnover ratios indicate that your company is effective at collecting payments (or possibly that you have a conservative collection policy). On the other hand, low turnover rates indicate your company struggles to collect payments effectively or that your customers are doing a poor job of making payments on time.
3 Ways to Improve Your Accounts Receivable Turnover Ratio
So, high turnover good, low turnover bad. But how would a company work to improve its turnover ratio?
1. Include payment terms
Let no customers claim ignorance as an excuse! Establish clear payment terms for customers and include those details on every invoice. Make it obvious that on-time payments are a priority, and your customers will follow suit.
2. Invoice correctly – and on time
Customers can’t pay on time if they don’t receive the invoice on time. Do your part to send invoices promptly, and make sure they’re accurate to avoid potential disputes. These are easy wins that boost your turnover rates.
3. Work on your customer relationships
Happy customers are more likely to pay on time. Start by working on your relationships and establishing regular communication. Something as simple as regular emails can help customers think of you as the service provider you are rather than some faceless company. This makes it more likely they’ll stick to their payment terms.
Accounts Receivable Turnover Is All About Efficiency
When reviewing A/R metrics in context (such as receivables turnover vs. days sales outstanding), it’s important to remember these indicators are a broad measure of collections efficiency. Without a structured, streamlined system for A/R management, you may always struggle to manage your turnover rates.
That’s why we recommend organizations explore the benefits of an automated A/R collections solution for their companies. With a partner like Gaviti, you’ll have more insight than ever into your A/R processes – and which specific improvement you can take to move things forward.
Contact us today to learn more.