The accounts receivable turnover plays a crucial role in helping financial professionals manage cash flow. It is sometimes referred to as “average receivable turnover ratio” and is classified as an efficiency metric.
So, what is accounts receivable turnover ratio? Managers use it to measure the effectiveness of their accounts receivable team and how well they collect on invoices owed. That, in turn, helps managers determine how well they manage their assets, which includes company inventory.
Accounts Receivable Turnover vs DSO
When looking at days sales outstanding vs accounts receivable turnover, the two metrics go hand-in-hand, but they are not the same. Days sales outstanding measures how many days it takes a company to turn credit sales into cash payments. Receivables turnover determines how often a company collects its average accounts receivable.
Both metrics can measure the performance of the accounts receivable team. However, while DSO measures collections, receivables turnover measures credit management.
Accounts Receivable Turnover Formula
When completing an accounts receivable turnover analysis, there are two specific components to keep in mind. “Net credit sales” refers to the sales revenue income the business received as credit payments during a specific period. “Average accounts receivable” refers to the average expected return for a specific period, which is determined by dividing the starting and ending balance of that period by 2.
Accounts receivable turnover rate =
Net Credit Sales / Average Accounts Receivable
Sometimes managers prefer to see the receivable turnover in days. To determine this, you simply divide 365 (calendar days) by the receivable turnover ratio.
Example of How To Use the Receivables Turnover Ratio
To better illustrate this, here’s an example:
Nicole is an organizational coach that helps business managers transition their teams from in-office to remote work. She allows her clients to pay for her services within a 30-day period. She received $200,000 in annual payments but returned $10,000 to one client to resolve a dispute. Starting and ending accounts receivable balances for the year was $10,000 and $30,000 respectively.
Accounts receivable turnover ratio:
Net Credit Sales: $200,000 – $10,000 = $190,000
Average Accounts Receivable:
($10,000 + $30,000) / 2 = $20,000
$190,000 / $20,000 = 9.5
What Is a Good Accounts Receivable Turnover Ratio?
Determining what counts as a good receivables turnover number can be tricky. There are a few factors to consider, such as the size of the company, its receivables turnover history, the industry it belongs to and its geographic location.
Consider that the average for Nicole’s industry and business size is 10. It would imply Nicole is just a little behind the average but not by much. In other words, it’s a good indicator to have a higher receivable turnover ratio than the average that applies to the business.
A higher ratio implies the following:
- The company is making good choices about who to extend credit.
- The company’s debt collection methods are effective.
- The customers are paying off their credit lines quickly.
How Can Companies Improve the Accounts Receivable Turnover Rate?
If you have a low or lower-than-average turnover, there are proven methods available to improve your cash flow management.
When a business is new or hits a slow period, it is tempting to extend generous credit terms to anyone. Unfortunately, this could lead to extending credit to customers with a higher risk of default. Complete a more thorough check to ensure people making credit purchases can afford to pay it back.
Imagine a monthly service that charges $10/month. This amounts to $120/year. However, the company states that if you pay the annual bill in full, it will give you a $20 discount, which drops your bill to $100. If you can afford to pay in full, chances are you will. Business customers think exactly the same way. Be sure to spend enough time determining how much of a discount you can afford to give.
Smart companies around the world are leveraging technology to calculate days sales outstanding and receivables turnover in real-time. This makes it easier to adequately manage cash flow without taking on expensive debt.
Find out how Gaviti can help by booking your demo today.