If the ratio exceeds that period substantially, then the collection process is definitely experiencing issues. The most common way to analyze if the ratio is healthy or not is to compare the result (in days) with the average credit period extended to clients.

On the other hand, a significantly high ratio it’s usually an indication that the collection process is working efficiently. It can be employed as an indicator of whether a further audit needs to be carried out on the receivables department, in order to understand why the metric is behaving as it is.Ī significantly low account receivables turnover ratio may indicate that the collection process is not effective and clients are taking more than they should to pay for their invoices. The accounts receivable turnover ratio has the capacity to signal potential billing and collection issues going on within the business. It appears the collection process has not been successful and that could be one of the reasons why the company is struggling with its cash flow. Nevertheless, Silver Cook has been implementing a strict policy on credit sales and the longest credit period they have been extending to clients is 15 days. This metric appears to be healthy, compared to perhaps other businesses. Currently, 165 days have passed since the year started, therefore the average number of days it takes the firm to collect receivables is:Īccounts Receivable Turnover Ratio (in days) = 165 / 6.14 = 27 days. This means that the company’s accounts receivable have been fully collected 6 times this year. The company’s year-to-date sales were $12,450,000 and accounts receivable at the beginning of the year were $1,850,000 and currently, $2,204,000. As a result, the CEO decided to investigate the reason for this and its initial step was to calculate the accounts receivable turnover ratio. The company recently evaluated its cash flow situation and the Financial Department warned the Board of Directors that in the next 6 months the company would incur in a cash deficit. The company has a small product line, that consists in 3 different products of different qualities, and each product has a different size, depending on the length of the foil.

Silver Cook is a company that manufactures and sells aluminum foil for households and businesses. Using the latest example, a company with an accounts receivable turnover ratio of 5 collects all of its receivables in 73 days, on average. On the other hand, in order to express the turnover ratio in days, which facilitates the interpretation of the ratio, the following formula can be employed:Īccounts Receivable Turnover Ratio (in days) = 365 / (Net Credit Sales / Avg. Receivables Turnover Ratio Equation in Days It also means, using the above-mentioned example, that the company has 20% of its sales tied up on receivables. For example, a ratio of 5 means that the accounts receivable have been collected 5 times during that time period.

The result of this formula is expressed as the number of times net credit sales have been collected during that time period. Accounts Receivables: The average between the total accounts receivable outstanding in the beginning of the time period being evaluated and the end period. Net Credit Sales: The aggregate revenues received and paid for through commercial credit.Īvg. Accounts Receivable AR Turnover Ratio Equation Components

Here’s how the account’s receivable turnover ratio formula can be calculated:Īccounts Receivable Turnover Ratio = Net Credit Sales / Avg. This makes the account receivables turnover ratio an important metric to follow up on. This is the case for wholesalers and manufacturing businesses that sell large volumes and usually have a substantial amount of money yet to be collected.Īlso, small to mid-sized businesses whose sales are highly concentrated within a handful of big clients can suffer severely from a delay in payment from any of them. On the other hand, companies are more susceptible to others when it comes to receivables.

5 Receivables Turnover Uses, Cautions, and Pitfallsīusinesses employ the account receivables turnover ratio to analyze the performance of their billing department, and also the quality of their client’s portfolio.

2.2 Receivables Turnover Ratio Equation in Days.

2.1 AR Turnover Ratio Equation Components.

Whats a good ar turnover ratio