How to Determine Accounts Receivable Turnover
Accounts receivable turnover is a crucial financial metric that helps businesses assess their efficiency in collecting payments from customers. It measures how quickly a company is able to convert its receivables into cash. In this article, we will discuss the steps to determine accounts receivable turnover and its significance in financial analysis.
Understanding Accounts Receivable Turnover
Accounts receivable turnover is calculated by dividing the net credit sales by the average accounts receivable. The formula is as follows:
Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Net credit sales refer to the total sales made on credit during a specific period, excluding any sales made for cash or any returns or allowances. Average accounts receivable is the average balance of accounts receivable over the same period.
Calculating Net Credit Sales
To calculate net credit sales, you need to gather the sales data for the period you are analyzing. This can typically be found in the company’s income statement or sales ledger. Subtract any sales returns, allowances, or discounts given to customers from the total credit sales to obtain the net credit sales figure.
Calculating Average Accounts Receivable
To calculate the average accounts receivable, you need to determine the opening and closing balances of accounts receivable for the period in question. Add these two figures together and divide by two to obtain the average.
Example Calculation
Let’s consider a company with the following data for the year 2021:
– Opening accounts receivable balance: $100,000
– Closing accounts receivable balance: $150,000
– Net credit sales: $1,000,000
First, calculate the average accounts receivable:
Average Accounts Receivable = (Opening Balance + Closing Balance) / 2
Average Accounts Receivable = ($100,000 + $150,000) / 2
Average Accounts Receivable = $125,000
Now, calculate the accounts receivable turnover:
Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Accounts Receivable Turnover = $1,000,000 / $125,000
Accounts Receivable Turnover = 8
This means that the company collected its accounts receivable eight times during the year.
Interpreting Accounts Receivable Turnover
A high accounts receivable turnover indicates that a company is efficient in collecting payments from customers, which is a positive sign. Conversely, a low turnover ratio suggests that the company may have issues with late payments or inefficient collection processes. It is important to compare the turnover ratio with industry benchmarks to gain a better understanding of the company’s performance.
Conclusion
Determining accounts receivable turnover is essential for businesses to evaluate their financial health and improve their cash flow management. By following the steps outlined in this article, companies can calculate their turnover ratio and make informed decisions to enhance their accounts receivable collection processes.
