The accounts receivable turnover ratio can be a helpful metric in determining the efficiency of your accounts receivable (AR) processes. The AR turnover ratio measures the number of times debts are collected from customers over a specified period.
Below, we cover how to calculate your AR turnover ratio and what it means for your company’s financial health.
Key takeaways
The accounts receivable turnover ratio represents the number of times a company's accounts receivable has been collected in a specific time period. It's metric that shows how many times your AR is converted into cash.
The ratio gives insight into the company's effectiveness of converting their AR to cash.
To calculate accounts receivables turnover, use the AR turnover formula:
AR turnover ratio = Net credit sales / average accounts receivable
In this formula...
Let's put the accounts receivable turnover formula into practice.
Consider Company A's relevant finances during an accounting period:
|
Net credit sales |
$85,000 |
|
Starting accounts receivable balance |
$10,000 |
|
Ending accounts receivable balance |
$13,000 |
First, calculate the average accounts receivable:
($10,000 + $13,000)/2 = $11,500
Then plug that value into the formula:
AR turnover ratio= $85,000/$11,500 = 7.4
Company A's accounts receivables turnover ratio would be 7.4, which would be considered a high ratio, depending on the industry.
AR turnover ratio measures your effectiveness at collecting debts. Your AR turnover ratio can give insight into your AR practices and what needs improvement.
A good accounts receivable turnover ratio is higher, but depends on the industry you're in.
Contrast this with accounts payable turnover, which measures how often you make your payments in a given period.
A higher ratio shows you're doing a better job at converting credit sales into cash. Your receivables turnover ratio can give insight into your AR whether your practices are leading to a healthier cash flow.
In general, the higher your AR turnover ratio is the better. A high ratio would be around 7 to 8, but what is considered a high ratio is also dependent on the industry you are in.
If you find you have a lower ratio for the industry you're in, consider looking at your AR process to see where you can improve your accounts receivable turnover.
If you have a high accounts receivable turnover ratio, this could mean you have managed your cash flow well, and have maintained stronger creditworthiness. A higher ratio could show your company collects its AR more efficiently.
Having a high turnover ratio doesn't necessarily mean everything is good though — this efficiency might be the result of a very conservative credit policy. A conservative credit policy means the company is perhaps overly selective about whom it extends credit to, possibly requiring stricter terms or quicker payments from customers. This could cause a company to lose out on potential sales.
If you have a lower accounts receivable turnover ratio, this could be a sign you are not managing your accounts receivable effectively. Perhaps your process isn't ideal, or your procedures for collecting from customers aren't efficient.
A low turnover ratio could also mean you are giving credit too easily, or your customer base is financially unreliable.
If you have a low ratio, consider ways you can improve your accounts receivable processes and efficiency. This could include implementing better policies for handling late payments, or adding automation to your AR process to speed up the steps needed.
AR turnover ratio and AP turnover ratio are both important but focus on difference aspects of financial health, just like how AR and AP themselves are different.
Key differences
Just like optimizing your AR process is important, so is optimizing your AP process.
There are multiple ways you can improve your accounts receivable turnover. It's important to think about your AR process as a whole and identify weak points to be improved. Improving your AR turnover ratio will directly improve your cash flow.
Sending invoices as soon as possible means faster payments. That being said, invoices must be accurate, as errors will slow down your collection process.
Ensure you have clear policies that maintain accuracy of the information on invoices, and procedures that send out invoices in a timely manner.
Automating your invoice management is a great way to do this.
Outlining clear payment terms for your customers will help to remove confusion for your customers on how, when, and how much to pay you. Ensure to follow up with your customers and still grant some flexibility if needed, like payment options or payment plans, for your customers.
Multiple payment options help make the payment process easier for customers. This helps drive customers to pay in a timely manner. Consider credit card, accepting online checks, and more.
Consider charging late fees for customers who pay late, this will incentivize customers to pay on time.
Sending reminders to customers helps keep them on track of paying on time. A friendly reminder can help to improve relationships and get payments quicker. If you have outstanding receivables, reminders can also help to collect payments from customers who are overdue.
Early payment discounts incentivizes faster payments from customers, and this ensures you get cash on time. This can help you to plan for your cash flow and gives you options with when you want to use that cash.
Stronger relationships with your customers can help you get paid on time, as customers feel a sense of loyalty and responsibility to maintain a good relationship and pay promptly for your goods/services. A strong customer relationship can create a high-quality customer base, improve customer satisfaction, and incentivize repurchasing.
Skip the steps of the accounts receivable collection process by getting payments in cash. This way you save time from the AR process, and you get cash on hand immediately. To encourage cash payments, for example, you could offer a discount to customers who pay in cash.
Implementing automation into your AR process can save you time and effort in collecting payments. With automation you can improve your accuracy and speed in sending invoices, and you can streamline and add visibility to your AR collection process.
Plooto's automation can help you manage your accounts receivable and improve your AR turnover ratio. Plooto offers automatic accounts reconciliation, setting up recurring payments, a variety of payment options, and visible tracking of invoices and payments.