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Accounts receivable turnover ratio is a financial metric which represents how fast or slow an account payable company, such as a business, will be able to pay back its creditors. It helps investors assess the risk that accounts receivables may not be paid in time and whether this could lead to default of payment.
The accounts receivable turnover ratio assesses a company’s ability to recover payment from consumers to whom it has granted credit. The ratio demonstrates how successful their credit policies and processes are, as well as how efficient their accounts receivable process is. This article explains how to calculate and interpret your A/R turnover ratio.
What Is the Turnover of Accounts Receivables Ratio?
The accounts receivable (A/R) turnover ratio is the number of times a company’s average accounts receivable total is collected in a particular period of time, usually a year. The average accounts receivable turnover ratio is computed by dividing net credit sales by the average accounts receivable amount.
The formula for the accounts receivable turnover ratio is:
(Beginning accounts receivable + Ending accounts receivable) / 2) Net Credit Sales
Calculation of the Accounts Receivable Turnover Ratio
The accounts receivable turnover ratio may be calculated in three simple steps. To begin, determine the average accounts receivable balance. The next step is to determine your net sales, which should be adjusted for any product returns and allowances. Finally, divide your net credit sales by your average accounts receivable level to arrive at your average accounts receivable balance.
To determine the accounts receivable turnover ratio, follow these steps:
1. Determine the average amount of accounts receivable
The average accounts receivable is the total amount owed by customers during a certain time period. The average accounts receivable balance is derived by multiplying the sum of the accounts receivable amounts at the beginning and end of the quarter by two. To get these data, you may use accounting software like QuickBooks to run a balance sheet report for the beginning and end of the quarter.
Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2
2. Determine the amount of net credit sales
The amount of income made by a company that lends credit to consumers is known as net credit sales. Any product returns, allowances or cash sales should not be included in this amount. This information may be found in your profit and loss statement, often known as the income statement. A QuickBooks income statement may be generated in a matter of minutes if you utilize accounting software like QuickBooks.
Net Credit Sales = Sales on Credit – Sales Returns – Sales Allowances
3. Subtract the average accounts receivable from the net credit sales.
You can compute the accounts receivable turnover ratio after calculating the average accounts receivable amount and getting the net credit sales for the period. Take the net credit sales and divide it by the average accounts receivable amount to get the A/R turnover ratio. Your accounts receivable turnover ratio is the end outcome.
Average Accounts Receivable / Net Credit Sales = Average Accounts Receivable
What Does the Accounts Receivable Turnover Ratio Mean?
What does your A/R turnover ratio signify now that you have it? Your A/R turnover ratio provides insight into your credit policy and collection procedures. A high A/R turnover ratio implies that you have a stringent credit policy in place as well as a good collections strategy in place to guarantee timely payments.
A low A/R turnover ratio, on the other hand, might indicate that your credit policy is overly lax, or perhaps nonexistent. It might also indicate that you want a more streamlined accounts receivable procedure, which includes invoicing clients quickly and issuing payment reminders prior to bills being due.
The accounts receivable turnover ratio, like other financial statistics, is merely one piece of information concerning a company’s capacity to collect from customers. Regardless of which direction your A/R ratio is moving, you’ll need to perform some more investigation to figure out what’s causing it. A high A/R turnover ratio, for example, might indicate that your credit policy is excessively severe, resulting in lost sales when clients who don’t satisfy your requirements choose a rival with a more flexible credit policy.
Finding out what the typical A/R turnover ratio is for your industry should be part of the research of your A/R turnover ratio trend. What an accounting service provider considers appropriate may not be acceptable to a photographer. Find out what the industry’s typical accounts receivable ratio is and compare it to yours to see how you stack up.
Examples of Accounts Receivable Turnover Ratios
We’ve included a few examples using two fake organizations to help you understand how to calculate the A/R turnover ratio. These examples should also help you understand what constitutes a high turnover ratio vs a low turnover ratio.
Two examples of how to calculate the accounts receivable turnover ratio are provided below:
ABC Company’s Accounts Receivable Turnover Ratio
Last year, ABC Company had the following outcomes:
- $1,300,000 in net credit sales
- At the start of the year, accounts receivable were $300,000, and at the conclusion of the year, they were $350,000.
ABC Company’s average accounts receivable is computed as follows:
($300,000 A/R at the start + $350,000 A/R at the end) / 2 = $325,000 Average A/R Balance
ABC Company’s average A/R turnover ratio is computed as follows:
Net Sales: $1,300,000 / Average A/R Balance: $325,000 = 4
ABC Company was able to collect its average accounts receivable total ($325,000) four times throughout the year, according to an accounts receivable turnover ratio of four.
XYZ Company’s Accounts Receivable Turnover Ratio
In the first six months, XYZ Company had the following results:
- Sales of net credit totaled $100,000.
- At the start of the year, accounts receivable were $10,000, and at the conclusion of the year, they were $20,000.
The following is how XYZ Company’s average accounts receivable is calculated:
($10,000 A/R at the start + $20,000 A/R at the end) / 2 = $15,000 Average A/R Balance
For XYZ Company, the average A/R turnover ratio is determined as follows:
$100,000 in net sales divided by $15,000 is 6.67.
With a turnover ratio of 7, XYZ Company was able to collect its average accounts receivable total ($15,000) seven times throughout the year.
How to Increase Your Accounts Receivable Turnover
You may wish to enhance your accounts receivable turnover ratio after calculating it and comparing it to the industry norm. Streamlining your accounts receivable process might help you increase your accounts receivable turnover. Many firms increase their efficiency by sending out timely invoices, sending out timely reminder emails, and accepting online payments.
You may boost your accounts receivable turnover ratio in three ways:
- Invoice clients promptly: After providing products or services, bill customers within one to two days. The longer you wait to submit an invoice to a client, the longer it will take for you to get paid.
- Review your accounts receivable aging report and send an email reminder to clients about payment a few days before the invoice due date. Your clients are busy, and a simple reminder may go a long way toward ensuring you get paid on time.
- Allow clients to pay their bills online by accepting online payments. Customers may get bills through email that contain a payment link, thanks to accounting software like QuickBooks. Customers need to do nothing more than click on the link, input their payment information, and complete their payment.
Accounts Receivables Turnover Ratio Calculation Reports
You’ll need your total net sales and average accounts receivable balance to determine your accounts receivable turnover ratio. You may receive this information from two reports in accounting software like QuickBooks: the balance sheet report and the profit and loss (income statement) report.
The steps to produce the reports you want from QuickBooks are as follows:
Using QuickBooks Online to Create Profit and Loss Reports
The profit and loss report, often known as the income statement, summarizes a company’s revenue and spending over a period of time (e.g., monthly, quarterly, annually). This report may be seen by going to the reports center. A link to the profit and loss report may be found in the company overview section. You may choose between a thorough and a summary report.
To create a profit and loss report in QuickBooks Online, follow the steps below:
1. Open QuickBooks Online and go to the Report Center.
Click the Reports tab from the left menu bar, as shown below:
2. In QuickBooks Online, choose the Profit & Loss Report.
In the company overview area, you’ll find many profit and loss reports. The summary form of the profit and loss statement may be run.
As seen below, choose the Profit and Loss report:
3. Choose a date range and generate a report
The report will appear once you click on profit and loss. The first subtotal on the report is the net sales amount, which is often known as total income.
The overall revenue (net sales) amount in the profit and loss report below is $449,657 for the period January through December 2022:
Using QuickBooks Online to Create a Balance Sheet Report
A balance sheet report outlines a company’s assets, liabilities, and equity at a certain moment in time (e.g., January 1). Navigate to the Report Center in QuickBooks to create this report. Several balance sheet reports may be found in the company overview section.
To begin, go to the Report Center.
Select the Reports tab from the left menu bar, as shown below:
2. In QuickBooks Online, create a Balance Sheet Report.
In the company overview area, you’ll find many balance sheet reports. As seen below, choose the balance sheet summary report:
3. Create a Balance Sheet Report at the Start of the Year
When you pick Balance Sheet Summary from the menu, the balance sheet report appears. Run the report for the year you’re working on’s January 1st. The accounts receivable amount at the start of the year will be shown at the very top of the report in the assets section.
The accounts receivable balance as of January 1, 2022, is $21,249, as shown in the balance sheet report below:
4. Create a year-end balance sheet report.
Set the deadline for the report to December 31, 2022. This is the balance of accounts receivable at the end of the year.
The accounts receivable balance as of December 31, 2022, is $93,008 as shown in the balance sheet report below:
Accounts Receivable Turnover Ratio Calculation
The A/R turnover ratio was derived using statistics from QuickBooks’ profit and loss and balance sheet reports:
(Beginning accounts receivable + Ending accounts receivable) / 2 = Net Credit Sales
3.93 = $449,657 / ($21,249 + $93,008) / 2 (round up to 4)
The average accounts receivable amount was collected four times between January 1 and December 31, 2022, according to an accounts receivable turnover ratio of four.
Template for Accounts Receivable Turnover Ratio for Free
To rapidly calculate your A/R turnover, use this free accounts receivable turnover ratio template.
Turnover of Accounts Receivables vs. Turnover of Accounts Payables
Accounts payable turnover ratio is diametrically opposed to accounts receivable turnover ratio. The accounts payable turnover ratio evaluates how fast a company pays its bills, while the accounts receivable turnover ratio examines how quickly a company can recover money from clients to whom it has granted credit.
A greater accounts payable turnover ratio, like the accounts receivable turnover ratio, is usually a desirable thing. It signifies that the company pays its vendors on schedule. A low A/P turnover ratio might indicate that a company isn’t paying its payments on time. As a result, your suppliers may reduce the amount of credit they give to you or eliminate credit terms entirely. To remain on top of overdue debts, keep an eye on your accounts payable aging report and make timely payments.
The Benefits and Drawbacks of the Accounts Receivable Turnover Ratio
The accounts receivable turnover ratio has both advantages and disadvantages. On the plus side, it may aid in cash flow forecasting, identifying and resolving consumer payment concerns, and evaluating the success of your credit policy. On the negative side, you must check the ratio on a regular basis (e.g., monthly, quarterly, yearly), devote time to additional investigation, and refrain from comparing yourself to organizations outside your field.
The following are the benefits and drawbacks of utilizing the A/R turnover ratio:
Advantages of Using A/R Turnover Ratio
The following are some of the advantages of employing the AR turnover ratio:
- Helps you anticipate cash flow: Knowing how often consumers pay allows you to plan and manage your spending as well as fulfilling your payment commitments to vendors and suppliers.
- Internal billing department difficulties are highlighted: A low A/R turnover ratio, as previously indicated, might suggest that consumers are not paying their bills on time. Other variables, though, might be at play. The billing department, for example, maybe delayed in sending bills out on time. If your A/R procedures have already been optimized, hiring another person to help with the burden may be the best option.
- Aids in determining the efficacy of present credit policies: If your accounts receivable turnover is very high or extremely low, it might suggest a problem with your credit policies and processes. A high A/R turnover ratio might suggest that your credit-extension rules are overly stringent. Customers who fell short of the goal due to a business credit score that was just a few points wrong may be denied credit.
The Disadvantages of Using the A/R Turnover Ratio
The following are some disadvantages of employing the AR turnover ratio:
- Regular evaluation is required: When you prepare financial statements, you should look at your A/R turnover ratio. The majority of small firms provide financial statements once a year. Make a year-over-year comparison to determine whether you’re heading upwards or downwards from the prior year. If you’re seeing a downward tendency, you should conduct some further research, such as looking at the ratio on a quarterly basis.
- Further investigation is required: As previously said, you cannot make judgments only based on your A/R turnover ratio. To figure out why you’re trending up or down, you’ll need to perform more research.
- Doesn’t allow for cross-industry comparisons: It’s like comparing apples to oranges when comparing your A/R turnover ratio to that of a firm in an entirely different sector. Compare your A/R turnover to comparable firms in your sector as a litmus test. When looking at liquidity ratios like the A/R turnover ratio, it’s important to remember that each industry has its own distinct characteristics.
Frequently Asked Questions (FAQs)
What is the formula for calculating accounts receivable turnover?
You must first determine the average accounts receivable amount in order to compute the accounts receivable turnover. This is accomplished by multiplying the initial and final accounts receivables by two. Next, divide your net credit sales by your average accounts receivable amount. Net credit sales are total sales on credit fewer sales returns and sales allowances.
What constitutes a satisfactory accounts receivable turnover?
The accounts receivable turnover rate is the number of times a company’s average accounts receivable amount is collected during a certain time period. The greater the accounts receivable turnover, the better in general. For example, a 15 A/R turnover ratio is preferable to 10. An A/R ratio of 15 indicates that the company collects its outstanding debt roughly 15 times each year.
Is there a provision for dubious accounts in the accounts receivable turnover?
Net sales are used to determine accounts receivable turnover. To calculate net sales, start with gross sales and subtract product returns, discounts, and allowances (also known as the allowance for dubious accounts), which are accounts that may become bad debt in the future. Net sales are the end outcome.
Conclusion
To summarize, the accounts receivable turnover ratio measures how fast you recover money owing to you by clients who have been given credit. It also reveals your credit policy and whether or not your current accounts receivable process and processes need to be improved. You can simply run the reports you need to compute your A/R turnover ratio if you utilize accounting software like QuickBooks.
