Accounts Receivable Turnover Ratio and How to Use It

The accounts receivable turnover ratio is an accounting metric that shows how well a company collects its receivables from customers. Knowing how to calculate and interpret the ratio will help you benchmark your receivables functions and take steps to improve them. 

What is the accounts receivable turnover ratio?

This is an efficiency ratio that shows how many times over a given period a company collects its average accounts receivable. We use the accounts receivable turnover ratio equation as follows: 

Net sales on credit ÷ Average accounts receivable

Where:

Net credit sales are those invoiced – not cash sales (less sales returns or allowances)

Average accounts receivable is the sum of the beginning and ending accounts receivable divided by 2.

If you want to know the accounts receivable ratio for the year, you add the accounts receivable balance at the beginning of the year to that at the end of the year and divide by 2. In this case, you would use annual credit sales (minus return and allowances) to get the ratio for the one-year accounting period. 

Now that we know how to calculate the accounts receivable turnover ratio, let’s consider a hypothetical example. 

Let’s say a business has $650,000 in credit sales for the year. Returns and allowances for that year were $35,000. Its net credit sales were $615,000. Its accounts receivable balance was $47,000 at the beginning of the financial year and $39,000 at the end of the financial year. So average accounts receivable for the 365 days was ($47,0000 + $39,000)  ÷ 2 = $43,000. The accounts receivable turnover ratio for business would be:

$615,000 ÷ $43,000 = 14.3

This is the number of times the business collects its average receivables in a year. A decrease in the accounts receivable turnover ratio indicates that customers are taking longer to pay.

Once you have the receivables turnover ratio formula, you can determine the average number of days it takes to collect a receivable by using the equation:

Receivable turnover in days = 365 ÷ Accounts receivable turnover ratio

In our example, this would be 365 ÷ 14.3 = 25.5. 

This number is also called debtor days and days sales outstanding. In this case, it takes around 25 days on average to get paid. If payment terms are 30 days, the business is getting paid a few days early, on average. Unfortunately, many businesses don’t get paid this quickly after invoicing customers. 

Research by Moula found that 65 per cent of SME customers don’t pay on time and nearly 40 per cent pay later than 30 days, regardless of the payment terms. In addition, research by Ilion details average late payment days by industry – from 10 days late for services businesses to 16 days late in the mining industry.

Fortunately, there are ways to increase the accounts receivable turnover ratio (and decrease the average days to get paid). These include: 

• Implementing credit policies and procedures – these can help you screen out risky customers, clearly communicate terms and improve collection processes. Learn more about Credit Policies and Procedures to Protect Your Business. 
• Invoice immediately after delivering products or services – doing this will clearly connect your products or services to the invoice. If you wait a few days or weeks, it will lessen the perceived urgency. Also, if you provide services that take time to deliver, consider invoicing regularly to get progress payments. 
• Make it easy for customers to pay you – offer several payment options, including bank transfers and credit cards. Make sure the amount, payment terms and payment options are clearly displayed on the invoice. Include contact details for clients to get in touch if they have any questions. 
• Automate accounts receivable – by automating accounts receivable you can send out reminders when invoices are not paid in time. Research by ezyCollect, an accounts receivable software developer, found that 59 per cent of overdue invoices require three or more follow-ups before they get paid. Your accounting software might include this feature or it usually can be added to an existing program.