Imagine running a café where customers enjoy their coffee and chats, but when it comes to settling the bill, they ask to pay later. Now, if too many customers delay, buying more coffee beans for the next morning might become tricky.
This is where understanding your accounts receivable turnover ratio comes in. It’s like keeping track of how quickly customers pay their tabs, ensuring you have enough cash on hand to keep the café bustling.
It’s the heartbeat of your business operations, enabling you to cover expenses, reinvest, and grow without unnecessary hitches. An optimized AR turnover means fewer “I’ll pay you later” and more “We’re ready for whatever comes next.”
In this article, we’ll break down what the AR turnover ratio is, why it’s crucial for your financial health, and share actionable tips on how you can improve it. Let’s dive in and turn those pending payments into ready cash!
Understanding Accounts Receivable Turnover Ratio
What is Accounts Receivable Turnover Ratio?
The accounts receivable turnover ratio, sometimes just called receivable turnover, is a way to measure how fast a company collects money it’s owed. Think of it as checking how quickly a business can turn the credit it gives to customers into actual cash within a year.
This ratio is part of the everyday accounting that keeps a business running smoothly. It also shows how well a company is handling the credit it extends to its customers and how fast it’s getting back the money it’s due.
Steps to Calculate Accounts Receivable Turnover Ratio
To figure out your accounts receivable turnover ratio, you need to first find two key numbers: net credit sales and average accounts receivable.
Here’s how you can do it step by step:
Calculate Average Accounts Receivable:
- Take the accounts receivable (AR) at the start and at the end of the period you’re looking at (it could be a month, quarter, or year).
- Add these two numbers together and divide by two. This average is the denominator for your turnover ratio calculation.
Calculate Net Credit Sales:
- This is the total sales made on credit, minus any sales returns or allowances. This figure is the numerator in your turnover ratio.
Calculate the Accounts Receivable Turnover Ratio:
- Use the formula: Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
- Make sure both numbers are from the same accounting period to keep things accurate.
Calculate AR Turnover in Days:
- If you want to drill down further, divide 365 days by your AR turnover ratio. This tells you, on average, how many days it takes to collect the receivables.
- Formula: Receivable Turnover in Days = 365 / Receivable Turnover Ratio
Although you can calculate this ratio annually, doing it monthly or quarterly can be especially helpful for small businesses that are growing and taking on new clients regularly. This helps them keep a close eye on how quickly they are collecting on their receivables.
“While it’s tempting to pull back, we believe that companies that double down on growth will not only rebound faster but will also emerge stronger as a result. “
Understanding Accounts Receivable Turnover Ratio with Examples
Every business needs to bill for its products or services and collect the payments as agreed. The way a company handles this process can really affect its finances, for better or worse.
High Turnover Ratio Example
A local doctor’s office takes both insurance and direct payments, mixing credit with immediate cash. Their accounts receivable turnover ratio stands at 10, meaning they collect payments every 36.5 days—a healthy cycle that supports their cash flow and goals. However, their strict credit rules could backfire if the economy dips or competitors offer more lenient terms and bigger discounts.