Accounts Receivable Turnover

Accounts receivable turnover (or simply receivables 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 or efficiency 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:

$$ \text{Receivables Turnover} \\ = \frac{\text{Net Credit Sales}}{\text{Average Accounts Receivable}} $$

We can obtain the net credit sales figure from the income statement or from the notes to the financial statements 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 may 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 favorable, if achieved by extremely strict credit terms since such policies may distance potential buyers thus reducing sales.

Examples

Example 1

Net credit sales of Company A during the year ended June 30, 20Y0 were $644,790. Its accounts receivable at July 1, 20X9 and June 30, 20Y0 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, 20X0 were $984,000. Customers returned goods invoiced at $31,400 during the year. Average accounts receivable during the period were $23,880. Calculate the 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 and last modified on

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