Accounts Receivable Turnover Ratio

What is the Accounts Receivable Turnover Ratio?


The accounts receivable turnover ratio measures a companies effectiveness in terms of qualifying their credit borrowers and collecting monies owed from them.  The A/R turnover ratio is an indication to how many times the accounts receivables are "turned over" throughout the year.  The higher the value of the ratio, the better the company is in terms of collecting their accounts receivables.  A lower accounts receivable turnover ratio indicates that the company is not making efficient use of their funds; remember, accounts receivables are basically grace periods that are given to customers to pay their bills.  It is essentially an interest free loan given to the customer.  There is an opportunity cost of doing this.

Like any other ratio, there is an exception.  If your accounts receivable turnover ratio is too high, it can indicate that the companies credit lending policies are too stringent, preventing prime borrowing candidates from becoming customers. 

Accounts Receivable Turnover Ratio

As you can see in the formula below, this formula is calculated using an average accounts receivable figure.  Therefore, you will need to take the period ending values off the balance sheet for the periods in question and average them.  Credit sales will need to be added up for the periods in question as well.  It is important to note that an average value can hide issues such as delinquencies if you have a few other balances which are paid immediately.  

Accounts Receivable Turnover Ratio

 

What is a good accounts receivable turover ratio?

A good turnover ratio is not as cut and dry as having a higher ratio than another company.  Industry, relative performance, and credit lending terms all play a part.  It is essential to compare apples with apples; meaning, measure the A/R turnover ratio against the industry average.  Each industry will have different lending and collection processes.  Also, it is very valuable to compare the current A/R turnover ratio against past values to gauge relative performance.

 

 

Tim Ord
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Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...

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