The accounts receivables turnover ratio measures the number of times a company collects its average accounts receivable balance. It is a quantification of a company’s effectiveness in collecting outstanding balances from clients and managing its line of credit process.
An efficient company has a higher accounts receivable turnover ratio, while an inefficient company has a lower ratio. This metric is commonly used to compare companies within the same industry to gauge whether they are on par with their competitors.
The receivables turnover ratio measures the efficiency with which a company is able to collect on its receivables or the credit it extends to customers. The ratio also measures how many times a company’s receivables are converted to cash in a certain period of time. The receivables turnover ratio is calculated on an annual, quarterly, or monthly basis.
Equation: Accounts Receivables Turnover = Net Credit Sales / Average Accounts Receivable
A high receivables turnover ratio can indicate that a company’s collection of accounts receivable is efficient and that it has a high proportion of quality customers who pay their debts quickly. A high receivables turnover ratio might also indicate that a company operates on a cash basis.
A high ratio can also suggest that a company is conservative when it comes to extending credit to its customers. Conservative credit policies can be beneficial since they may help companies avoid extending credit to customers who may not be able to pay on time.
On the other hand, having too conservative a credit policy may drive away potential customers. These customers may then do business with competitors who can offer and extend them the credit they need. If a company loses clients or suffers slow growth, it may be better off loosening its credit policy to improve sales, even though it might lead to a lower accounts receivable turnover ratio.
Accounts receivable turnover ratio calculations will widely vary from industry to industry. In addition, larger companies may be more wiling to offer longer credit periods as it is less reliant on credit sales. In general, a higher accounts receivable turnover ratio is favourable, and companies should strive for at least a ratio of at least 1.0 to ensure it collects the full amount of average accounts receivable at least one time during a period.
Source: Investopedia
