This article is part of a larger series on Bookkeeping.
The accounts receivable (A/R) turnover ratio is helpful in managing your accounts receivable and measures how effectively a business collects payment from customers they have extended credit to within a given period―generally one year. It also shows how effective its credit policy and procedures are and how streamlined its A/R process is. Managing the A/R process is a fundamental bookkeeping task that can make a major impact on the cash flow of your business.
The A/R turnover ratio formula is:
Net Credit Sales / [(Beginning A/R + Ending A/R) / 2]
How To Calculate Accounts Receivable Turnover Ratio
Step 1: Calculate Average A/R
The average A/R is the balance owed by customers in a given period. It’s calculated by adding the A/R balances at the start and end of the period and dividing the total by two.
Average A/R = (Beginning A/R + Ending A/R) / 2
Step 2: Identify Net Credit Sales
Net credit sales is the amount of revenue generated that a business extends to customers on credit. This figure shouldn’t include any product returns, allowances, and cash sales. You can obtain this information from your profit and loss (P&L) report, also known as the income statement.
Net Credit Sales = Sales on Credit – Sales Returns – Sales Allowances
Note that you can generate an income statement on QuickBooks in a few minutes.
Step 3: Divide Net Credit Sales by Average A/R
After calculating the average A/R balance and obtaining the net credit sales for the period, you can calculate the A/R turnover ratio. Take the net credit sales and divide it by the average A/R balance.
A/R Turnover Ratio = Net Credit Sales / Average A/R
How To Interpret the Accounts Receivable Turnover Ratio
Similar to other financial ratios, the A/R turnover ratio is only one piece of information about a business’s ability to collect from its customers. It gives you information about your credit policy and collection process.
- A high A/R turnover ratio means you collect from customers quickly, indicating that you have a strict credit policy and a solid collections process in place to ensure prompt payments. A very high A/R turnover ratio, however, could mean your credit policy is too strict and is causing lost sales because customers who don’t meet your criteria choose a competitor with a more flexible credit policy.
- A low A/R turnover ratio could mean your credit policy is too loose or maybe even nonexistent. It could also be an indication that you need a more streamlined A/R process that includes promptly invoicing customers and sending payment reminders before invoices become due.
Whichever way your A/R ratio is trending, you’ll need to do additional research to determine the cause. Part of your analysis should be finding out what the average A/R turnover ratio is for your industry to see how yours matches up. What’s acceptable for a bookkeeping service company may not be acceptable for a photographer.
Accounts Receivable Turnover Ratio Examples
For you to have a good grasp of how to calculate the A/R turnover ratio, we provided examples using two fictitious companies.
Sample 1: Accounts Receivable Turnover Ratio for ABC Company
ABC Company had the following results last year:
- Net credit sales: $1.3 million
- Beginning A/R: $300,000
- Ending A/R: $350,000
The average A/R for ABC Company is calculated as follows:
($300,000 Beginning A/R + $350,000 Ending A/R) / 2 = $325,000 Average A/R Balance
The average A/R turnover ratio for ABC Company is calculated as follows:
$1.3 million Net Sales / $325,000 Average A/R Balance = 4 Average A/R Turnover Ratio
An A/R turnover ratio of 4 means ABC Company was able to collect its average A/R balance ($325,000) about four times throughout the year.
Sample 2: Accounts Receivable Turnover Ratio for XYZ Company
XYZ Company had the following results in the first year:
- Net credit sales: $100,000
- Beginning A/R: $10,000
- Ending A/R: $20,000
The average A/R for XYZ Company is calculated as follows:
($10,000 Beginning A/R + $20,000 Ending A/R) / 2 = $15,000 Average A/R Balance
The average A/R turnover ratio for XYZ Company is calculated as follows:
$100,000 Net Sales / $15,000 Average A/R Balance = 6.67 Average A/R Turnover Ratio
An A/R turnover ratio of about 7 means XYZ Company was able to collect its average A/R balance ($15,000) about seven times throughout the year. This is a higher A/R turnover ratio than ABC Company in Sample 1, which means that XYZ is collecting from customers faster than ABC.
Ways To Improve Your Accounts Receivable Turnover Ratio
After calculating your A/R turnover ratio and comparing it to the industry standard, you may want to improve it. Streamlining your A/R process can go a long way toward increasing your A/R turnover. Many businesses improve their efficiency with prompt invoices, timely reminder emails, and online payment options.
- Invoice customers promptly: Bill customers within one to two days after you have provided goods or services. The longer you take to send a customer their invoice, the longer it takes for you to get paid.
- Send reminder emails about payment: Review your A/R aging report, and send an email reminder to customers a few days before the invoice due date. Your customers have a lot on their plate, so a simple payment reminder can go a long way to ensure you receive it on time.
- Accept online payments: Give customers the option to pay their invoices online. Accounting software like QuickBooks Online allows you to invoice customers via an email that includes a payment link. Customers simply click on the link, enter payment details, and submit their payment.
Frequently Asked Questions (FAQs)
How do you calculate the accounts receivable turnover?
To calculate the A/R turnover, you first need to find the average A/R balance. This is done by adding the beginning and ending A/R and dividing by two. Next, take your net credit sales, which is the total sales on credit minus sales returns and sales allowances, and divide it by the average A/R balance.
What does accounts receivable turnover say about a company?
The A/R turnover provides a snapshot of the company’s ability to quickly collect receivables from customers. The goal of this metric is to show how many times a year your company collects on its customer debt, which will help indicate whether you should initiate debt collection efforts or shorten the credit terms you offer customers. The higher the A/R turnover, the better it’s for the company, leading to fewer bad debts and less overall risk.
What is the difference between the A/R turnover ratio and day sales outstanding?
The accounts receivable turnover ratio measures how many times per year a business can collect its A/R, whereas day sales outstanding (DSO) is a metric that represents how long it takes a business to collect an A/R from a customer after the sale. Both measures capture the same information but in a slightly different way.
This is the formula for calculating DSO:
(A/R / Credit sales) x Number of days
The goal is to maintain a low DSO number because a low DSO reflects quicker cash collection.
The accounts receivable turnover ratio tells you how quickly you can collect on the money owed to you by customers who have been granted credit privileges. It also provides insight into your credit policy and whether you need to improve upon your existing A/R process and procedures. If you use accounting software like QuickBooks, you can run the reports you need to calculate your A/R turnover ratio quickly.
QuickBooks is the top accounting software we recommend to small businesses. You can track all of your income and expenses and streamline your A/R process by invoicing customers and accepting online payments. Sign up today, and you can qualify for up to 50% off QuickBooks for three months.