Definition and Examples of Accounts Receivable Turnover Ratio
The accounts receivable turnover ratio formula helps calculate how quickly a company converts its accounts receivable into cash over a specific period. The accounts receivable turnover ratio tells you how quickly the company can turn its accounts receivable into cash. To find the accounts receivable turnover ratio, divide credit sales by the average accounts receivable. The resulting figure will tell you how many times the company collects its outstanding payments from customers.
How to Calculate the Accounts Receivable Turnover Ratio
The accounts receivable turnover ratio is a great financial ratio to learn when analyzing a business or stock. It’s simple logic: the faster a company collects its accounts receivable, the better. Fortunately, there’s a way to calculate how well the company is collecting its accounts receivable. The accounts receivable turnover ratio formula takes credit sales divided by the average accounts receivable to find the number of times.
How the Accounts Receivable Turnover Ratio Works
To understand how this ratio works, imagine the hypothetical company H.F. Beverages, a manufacturer of soft drinks and fruit juices. It sells to supermarkets and grocery stores across the country, offering its clients 30-day terms. This means that customers have 30 days to pay for the beverages they ordered.
To find out if customers are paying on time, you need to look at the income statement. This is usually found on one or two pages of the financial statements in the company’s annual report or 10K filing. With the income statement in front of you, look for an item called “Credit Sales.”
In 2020, H.F. Beverages reported credit sales of $15,608,300. To find the average accounts receivable, look at the figures from 2020 and 2019. It had $1,183,363 in accounts receivable in 2020, and in 2019, it reported accounts receivable of $1,178,423.
Add the two accounts receivable figures ($1,183,363 + $1,178,423) and divide by two. This gives you an average accounts receivable of $1,180,893.
Now you have the numbers you need to calculate the equation. Just plug in the numbers: Credit Sales ÷ Average Accounts Receivable = Number of Times Accounts Receivable. $15,608,300 ÷ $1,180,893 = Number of Times Accounts Receivable 13.2174.
This means that H.F. Beverages collects its accounts receivable 13.2174 times a year on average. Once you calculate this number, you can take an additional step to find out how many days it takes the average customer to pay their bills. With 365 days in a year and collecting 13.2174 times a year, divide 365 by 13.2174. The answer is how many days it takes the average customer to pay. In H.F.’s case, you should get about 27.62.
Interpreting the Result
Calculating the accounts receivable turnover ratio can quickly tell you how efficiently a company manages its accounts receivable. A poorly managed company allows its customers to exceed the agreed-upon payment schedule. A well-managed company gets its customers to adhere to the schedule.
In the case of H.F. Beverages, it appears that the company is doing well managing its accounts receivable because customers are not exceeding the 30-day policy. If the answer is greater than 30, wise investors will try to determine why so many customers are paying overdue. Late payments can indicate a problem, whether in management style or financial footing.
You must remember that you’ll need to read the company reports to know when they expect to receive payments. Not all companies require customers to pay within 30 days.
All
Different companies will not all conduct a large part of their sales on credit. However, many companies regularly extend credit to customers. When they do so, it is important to understand how effectively they manage their customer credit. A company that manages the credit it extends better may be a better choice for investors.
Source: https://www.thebalancemoney.com/receivable-turns-357293
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