The Receivables Turnover Ratio | Business Owners Must Know

By | March 7, 2018

What Everyone Must Know About Receivables Turnover Ratio

Intro to Ratio of Receivables Turnover:

The receivables Turnover Ratio is an accounting indicator of efficiency ratio. Companies use it to measure in which company is charging its accounts receivable. It indicates the speed of a company’s debt collection during a given period. This measure indicates how efficient the company is with the use of its assets. Sales are classified, as accounts receivable are sales made on credit. This means that the supplier is financing the purchase of goods and services. For which their management is of the utmost importance.

Accounts receivable turnover defined by dividing the number of net sales between the balances charged to customers. Accounts receivable are the total of short-term loans granted and not yet recovered. That represents an efficient indicator of the administrative management of a business.

Please note that receivable turnover ratio has a lot of names to be called such as debtor’s turnover ratio, the accounts receivable turnover ratio, or the accounts receivable turnover.

The number of times that customer balances have recovered during the year is determined. Dividing 360 between the given indexes gives us the number of days it takes to collect customer accounts. This relationship is an indication of the efficiency of a company in the collection of sales on credit. The calculation of this relationship is only included the sale of credit. The higher ratio is the greater efficiency of a desirable aspect of any company. The rotation of accounts receivable is calculated using the following formula:

  • Receivables Turnover Ratio = Net Credit Sales /Average Accounts Receivable in a year

Where,

  • Net credit sales = total sales, with the help of the credit, minus all applicable deductions that may also include the interest rate according to the company’s policy.
  • Average accounts receivable = Total debts pending collection / number of debtors.

However, payables turnover is exactly opposite of the accounts receivable turnover. If you are interested reading this, then search it here. Payables turnover also called as creditors turnover ratio.

Why is Receivables Turnover Ratio important?

The management of your business allows you to identify quickly. It is with a few simple calculations the health of various aspects of your business. The financial report aspect of your operation is to continue operating and face the future. Do you know the status of your accounts receivable?  The ratio known as Receivables Turnover Ratio can be a valuable tool for controlling the money you owe on credit sales. This indicator measures the number of times accounts receivable are collected during the period under analysis. It determined by dividing the number of net credit sales by the average of the receivables account.

The turnover of accounts receivable can mean several things. A high turnover may imply that the company operates in an industry where cash flow is available. That is being efficient in the collection of their accounts. It can also mean that most of your clients are good, have liquidity, and pay their debts quickly. This may mean that the company is conservative with its credit policies. This can be good since they are careful to whom they extend credit. On the other hand, it can also be bad since policies can be too conservative. It can lose potential customers that the competition can capture. In this case, you should evaluate if you want to modify the credit policies to increase sales.

A low receivable turnover ratio may indicate that the company has poor collection processes and a bad credit policy. It can also mean that customers are having financial difficulties or that the industry is going through a difficult time. A company with a low turnover should improve its collections processes as well as evaluate its credit policy in order to accelerate the collection of accounts receivable. It also shows in balance sheet also.

Receivables Turnover Ratio

Analysis: (Breaking Down)

The recent measure that the trade has rapidly modernized, the role of accounting is not limited to inform the administration. It has become significantly analytical is nature. Accountants and financial analysts are using debtor’s turnover ratio as analysis tools. The proportion is a tool that measures the situation of accounts receivable turnover. This ratio is approximately an asset it is not an asset turnover ratio. Therefore, has to treat very differently than the rotation ratios of usual total assets. Here is an explanation of the reason for account rotation. You can use the online accounts receivable turnover calculator to get correct info abo the t receivable ratio. Or you can do it manually following below.

To calculate the turnover of accounts receivable, suppose that a company has $ 1 million in sales on credit and at the beginning of the year they had $ 100 thousand dollars in accounts receivable and at the end of the year they had $ 150 thousand dollars. With this information and using the formula, we can obtain the following:

  • $ 1,000,000 / [($ 100,000 + $ 150,000]) / 2] = $ 1,000,000 / ($ 250,000 / 2)
  • $ 1,000,000 / $ 125,000 = 8

This number tells us how many times a company collects accounts receivable in a year. By dividing this number by 365 days, we obtain the average duration of these pending receivables until they are charged. The account receivable days are very significant for any company.

In this case, it would be 365 days / 8. This results in 45.62 days. This number could be good or bad. Let us suppose that the terms of credit that the company offers are 30 days in all its sales. In this case, the business would have a problem with the average amount. It is collecting its accounts receivable 15 days (45.62 days – 30 credit days) after the expiration of invoices. The company could offer a prompt payment incentive to try to accelerate the collection of accounts. You could also compare yourself to other companies in the industry. See if your terms of payment are competitive.

Index of accounts receivable turnover ratio:

The interpretation of the turnover rate of accounts receivable is quite complicated. The output of the formula is mainly the number of times that the credit accounts are collected or will collect. The interpretation usually depends on the benchmarks. It is very important to pay attention to this ratio. Because if it is low or decreases the company may run the risk of having many credits receivable and has not liquid assets to meet their own obligations.The calculation period depends on the debts and company policies. The turnover rate of accounts receivable in some cases is calculated on an hourly basis. While in some cases, it calculated even on an annual basis. The banking and financial companies, calculate this figure for each account on a daily basis for a better understanding of the recovery of the debt.

The net sales of credit are not always equal to the total amount of the debt incurred. It may be more in time and maybe less. There is a golden rule that can follow. A higher proportion indicates that transactions are processed on time and that all debtors are paying on time. A smaller proportion spells an alarm, demanding a policy change, as it indicates more defaults and defaults. A large volume of cash sales gives a great discourtesy turnover rate of accounts receivable. Something that is inevitable. However, in order to avoid such a deceptive figure. All cash sales or reimbursed amounts deducted from the balance sheet almost every day. Some companies also add the amount of interest receivable to the formula.

Accounts receivable is the part of current assets originated by credit sales. This concept includes accounts receivable originated by commercial operations. There are accounts receivable that do not come from the current operations of a business.  One of the main variables of the collection policy is the cost of collection procedures. The relationship between the cost of collections and their efficiency is not linear. The first collection expenses are likely to produce a very little reduction of uncollectible accounts.

Limitations:

Accounts receivable turnover has some limitations too. Similar any metric endeavoring to scale the productivity of a business, the accounts receivable turnover arises using a set of limits that are essential for any investor to think about beforehand implementing it. Another vital topic to study is that businesses will occasionally use total sales as an alternative to net sales while measuring their ratio, which usually pumps up the turnover ratio. It also represents chart of accounts also.

But this is not all the time certainly destined to be intentionally misrepresentative, generally one must try to establish how a business analyzes their ratio previously accepting it at face value, or else ought to estimate the ratio self-reliant.

Lastly, a low ratio may not essentially specify that the firms supplying of credit and accumulating of debt is deficient. If, for instance, distribution malfunctioned and fails to get the precise merchandise to consumers, consumers might not pay, which would likewise drop the company’s debtor’s turnover ratio.

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