What is Accounts Receivable Turnover Ratio?

May 8, 2024

The accounts receivable turnover ratio (AR turnover ratio), also known as the debtors’ turnover ratio, is a metric used to assess a company’s efficiency in collecting payments from credit sales. It essentially measures how many times a company sells and collects its average accounts receivable balance within a specific period, typically a year.

Understanding AR Turnover

Focuses on Collection Speed: A higher AR turnover ratio indicates a company collects its credit sales faster, signifying better collection efficiency and healthier cash flow.

Efficiency Benchmark: By comparing the AR turnover ratio to industry averages or the company’s historical performance, you can gauge its collection efficiency relative to peers or its own past performance.

Calculating AR Turnover Ratio

The formula for calculating the AR turnover ratio is

AR Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Net Credit Sales

Net Credit Sales represent the total revenue generated from selling products or services on credit during a specific period (usually a year). This is not the same as the total sales figure, which would include both cash and credit sales.

To calculate Net Credit Sales, start with the gross credit sales figure (total sales on credit before adjustments). Then, subtract any returns or allowances associated with those credit sales.

  • Returns: These occur when customers return merchandise they purchased on credit. The returned amount is deducted from the original credit sale.
  • Allowances: These are price reductions offered to customers for damaged goods, errors on invoices, or other reasons. The allowance amount is deducted from the original credit sale.

Average Accounts Receivable

This reflects the typical amount of money owed to the company by its customers on credit sales at any given time within a specific period. It provides an average picture of the outstanding AR balance throughout the period.

There are two common ways to calculate Average Accounts Receivable:

  • Simple Average: This method adds the beginning and ending accounts receivable balances for the period and divides them by the number of periods (months in a quarter or quarters in a year).

Formula: Average AR (Simple) = (Beginning AR Balance + Ending AR Balance) / Number of Periods

  • Weighted Average: This method assigns weights (usually based on the number of days in each period) to the ending AR balance for each period and then divides the sum of these weighted balances by the total number of days in the period. This approach provides a more accurate picture if the ending AR balance fluctuates significantly throughout the period.

The specific calculation for a weighted average AR involves more steps and can be found in accounting resources.

Interpreting AR Turnover Ratio

A higher AR turnover ratio is generally preferable as it indicates a faster collection of payments. However, it’s important to consider industry standards and context:

Industry Benchmarks

Certain industries naturally have longer payment cycles. Comparing your AR turnover ratio to industry averages can provide a more meaningful interpretation.

Company-Specific Factors

Factors like credit terms offered, customer base, and collection practices can influence the AR turnover ratio.

AR Turnover Ratio and Average Collection Period

The AR turnover ratio is closely related to the average collection period (ACP), also known as days sales outstanding (DSO). 

FeatureAR Turnover RatioAverage Collection Period (ACP)
FocusCollection Efficiency (Speed)Collection Efficiency (Duration)
InterpretationHigher ratio indicates faster collectionsLower number indicates faster collections
FormulaNet Credit Sales / Average Accounts Receivable(Average Accounts Receivable / Net Credit Sales) x 365
ResultNumber of times AR is “turned over” in a period (e.g., year)Number of days it takes to collect on average sales
Industry ComparisonCompared to industry benchmarks to assess relative efficiencyCompared to industry benchmarks to assess relative efficiency
ContextConsider credit terms offered and the customer baseConsider credit terms offered and the customer base
RelationshipAR Turnover Ratio = 365 / Average Collection PeriodThey are reciprocal concepts

AR Turnover Ratio = 365 / Average Collection Period (ACP)

Therefore, a higher AR turnover ratio translates to a lower average collection period, indicating faster collections.

In conclusion, the accounts receivable turnover ratio is a crucial part of accounts receivable management and a valuable metric for businesses to assess their collection efficiency and cash flow management. By analyzing this ratio, businesses can identify areas for improvement in their credit and collection processes, ultimately leading to faster collections and a healthier financial bottom line.

To focus on core functions of the business, outsourcing accounts receivable is a good choice for businesses. A professional BPO company that provides accounts receivable management services can assist companies and will ensure a timely receipt. 

First Credit Services is a business process outsourcing company specializing in accounts receivable management, credit collections, etc. The company also provides first-party collections, which involves collecting payments on due invoices before they become significantly overdue. Our experts will intricately oversee your financial records, streamline your operations, and grant invaluable insights to facilitate well-informed business choices. Contact us today to learn more!

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