Accounts Receivable Turnover Ratio

Accounts receivable turnover is the ratio of net credit sales of a business to its average accounts receivable during a given period, usually a year. It is an activity ratio which estimates the number of times a business collects its average accounts receivable balance during a period.

Formula

Accounts receivable turnover is calculated using the following formula:

Receivables=Net Credit Sales
TurnoverAverage Accounts Receivable

We can obtain the net credit sales figure from the income statement of a company. Average accounts receivable figure may be calculated simply by dividing the sum of beginning and ending accounts receivable by 2. The beginning and ending accounts receivable can be found on the balance sheets of the first and the last day of the accounting period.

Accounts receivable turnover is usually calculated on annual basis, however for the purpose of creating trends, it is more meaningful to calculate it on monthly or quarterly basis.

Analysis

Accounts receivable turnover measures the efficiency of a business in collecting its credit sales. Generally a high value of accounts receivable turnover is favorable and lower figure may indicate inefficiency in collecting outstanding sales. Increase in accounts receivable turnover overtime generally indicates improvement in the process of cash collection on credit sales.

However, a normal level of receivables turnover is different for different industries. Also, very high values of this ratio may not be favourable, if achieved by extremely strict credit terms since such policies may repel potential buyers.

Examples

Example 1: Net credit sales of Company A during the year ended June 30, 2010 were $644,790. Its accounts receivable at July 1, 2009 and June 30, 2010 were $43,300 and $51,730 respectively. Calculate the receivables turnover ratio.

Solution
Average Accounts Receivable = ($43,300 + $51,730) ÷ 2 = $47,515
Receivables Turnover Ratio = $644,790 ÷ $47,515 ≈ 13.57

Example 2: Total sales of Company B during the year ended December 31, 2010 were $984,000. Customers returned goods invoiced at $31,400 during the year. Average accounts receivable during the period were $23,880. Calculate accounts receivable turnover ratio.

Solution
Net Credit Sales = $984,000 − $31,400 = $952,600
Receivables Turnover = $952,600 ÷ $23,880 ≈ 39.89

Written by Irfanullah Jan