Receivable Turnover Ratio
The receivable turnover ratio (debtors turnover ratio, accounts receivable turnover ratio) indicates the velocity of a company's debt collection, the number of times average receivables are turned over during a year. This ratio determines how quickly a company collects outstanding cash balances from its customers during an accounting period. It is an important indicator of a company's financial and operational performance and can be used to determine if a company is having difficulties collecting sales made on credit.
Receivable turnover ratio indicates how many times, on average, account receivables are collected during a year (sales divided by the average of accounts receivables). A popular variant of the receivables turnover ratio is to convert it into an Average collection period in terms of days. The average collection period (also called Days Sales Outstanding (DSO)) is the number of days, on average, that it takes a company to collect its accounts receivables, i.e. the average number of days required to convert receivables into cash.
An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts.
Receivable Turnover Calculation (Formula)
where "Net Sales" is the total sales for a given period and "Average Accounts Receivable" is the average accounts receivable balance for the same period.
Interpretation: A higher ratio indicates that a company is effectively managing its accounts receivable and collecting payments quickly, while a lower ratio may indicate that a company is having trouble collecting payments and may be a warning sign of potential financial problems.
A low receivables turnover ratio could mean that a company is extending long payment terms to its customers, which could be hurting its cash flow. It could also indicate that a company is having trouble collecting its accounts receivable, which could be a sign of financial distress. Additionally, a low ratio could be the result of a company having a large volume of uncollectible accounts, which could impact its profitability and financial stability.
Accounts Receivable outstanding in days:
Average collection period (Days sales outstanding) = 365 / Receivables Turnover Ratio
Time frame: The receivables turnover ratio should be evaluated over a period of time to get a complete picture of a company's credit and collection processes. A single ratio for a single period may not provide an accurate picture of the company's financial health.
Receivables Turnover Ratio Standards and Limits
There is no general norm for the receivables turnover ratio, it strongly depends on the industry and other factors. The higher the value of receivable turnover the more efficient is the management of debtors or more liquid the debtors are, the better the company is in terms of collecting their accounts receivables. Similarly, low debtors turnover ratio implies inefficient management of debtors or less liquid debtors. But in some cases too high ratio can indicate that the company's credit lending policies are too stringent, preventing prime borrowing candidates from becoming customers.
The optimal level of the receivables turnover ratio can vary depending on the industry in which a company operates. For example, companies in the retail industry generally have a higher receivables turnover ratio than companies in the construction or real estate industries, as payments for retail goods are typically collected more quickly than payments for large construction projects.
Limitations: The receivables turnover ratio does not take into account the quality of the accounts receivable, and may be misleading if a company has a high volume of uncollectible accounts. It is important to consider the ratio in conjunction with other financial metrics and information to get a complete picture of a company's financial health.
Exact formula in the ReadyRatios analytic software
Average collection period = ((F1[b][TradeAndOtherCurrentReceivables] + F1[e][TradeAndOtherCurrentReceivables])/2)/(F2[Revenue]/NUM_DAYS)
Receivables turnover ratio = 365 / Average collection period
F2 – Statement of comprehensive income (IFRS).
F1[b], F1[e] - Statement of financial position (at the [b]eginning and at the [e]nd of the analizing period).
NUM_DAYS – Number of days in the analizing period.
365 – Days in year.
Receivables Turnover Ratio Industry Benchmark
How to improve company's receivables turnover ratio
There are several steps a company can take to improve its receivables turnover ratio:
- Streamline credit and collection processes. A company can improve its ratio by streamlining its credit and collection processes to make sure that it is effectively managing its accounts receivable and collecting payments in a timely manner.
- Offer incentives for early payment. Offering early payment discounts or other incentives to customers can encourage them to pay their invoices more quickly, which will improve the company's ratio.
- Evaluate credit policies. A company should regularly evaluate its credit policies to make sure that it is granting credit only to customers who are capable of paying. If necessary, the company should tighten its credit policies to reduce the amount of accounts receivable it has to manage.
- Monitor accounts receivable. A company should regularly monitor its accounts receivable to identify any potential issues and take action to address them. This can include following up with customers who are late on their payments, renegotiating payment terms, or writing off uncollectible accounts.
- Implement automated systems. Implementing automated systems, such as electronic invoicing and online payment systems, can make the credit and collection process more efficient and reduce the amount of time it takes to collect accounts receivable.
- Foster positive relationships with customers. Building positive relationships with customers can encourage them to pay their invoices more quickly and reduce the likelihood of payment issues. This can involve providing excellent customer service, timely responses to customer inquiries, and addressing any concerns or problems in a timely manner.