Accounts receivable turnover is a part of efficiency ratio that calculates how often a business can convert its accounts receivable into cash during a given period of time. Simply put, the accounts receivable turnover ratio calculates how many times a business can collect its average accounts receivable during the year.

When a company gathers its average receivables, it is referred to as turn. If a business had $30,000 of average receivables during the year and brought in $60,000 of receivables during the year, the company would have turned its accounts receivable twice because it collected twice the amount of average receivables.

This ratio is a reflection of how effectively a company is collecting its credit sales from customers. Some companies receive their dues from customers in 90 days while other take up to 6 months to collect from customers.

The formula to calculate Accounts Receivable Turnover Ratio is:

Accounts Receivable Turnover Ratio = Net Credit Sales/Average Accounts Receivable

Implication of Accounts Receivable Turnover Ratio

Now we know that the receivables turnover ratio calculates a business’ ability to effectively collect its receivables, it is quite clear that a higher ratio would be more beneficial. Higher ratios suggests that companies are bringing in their receivables more frequently throughout the year. For example: a ratio of 2 shows that the company collected its average receivables twice during the year. In other words, every six months, the company is collecting money from its customers.

Higher efficiency is beneficial from a cash flow point of view as well. If a company brings in cash from customers quicker, the cash can be used in payment of bills and other obligations quicker.

Example

A retail store named ABC deals in outdoor skiing equipment. The owner offers accounts to all of his major customers. At the end of the year, Bill’s balance sheet shows the accounts receivable as $20,000, gross credit sales of $75,000 and $25,000 of returns. Last year’s balance sheet showed $10,000 of accounts receivable.

To calculate ABC’s turnover we will have to calculate net credit sales and average accounts receivable. To calculate net credit sales, well have to returns from the gross cfredit sales which gives us            (75000 – 25000 = 50,000). Average accounts receivable can be calculated by averaging beginning and ending accounts receivable balances ((10,000 + 20,000) / 2 = 15,000).

So, this will give us the result as:

Accounts Receivable Turnover Ratio : $50,000/$15000

Accounts Receivable Turnover Ratio : 3.33

The figure 3.33 indicates that ABC collects his receivables about 3.3 times a year or once every 110 days. Simply put, when ABC makes a credit sale, in every 110 days it will collect the cash from that sale.