The accounts receivable (A/R) turnover ratio is helpful in managing your A/R and measures how effectively a business collects payment from customers they have extended credit to within a given period―generally one year. Analyzing the A/R turnover should include industry benchmarks to give you a full understanding of whether the company is doing fine at an industry level.
The A/R turnover ratio formula is:
| A/R Turnover | = | Net Credit Sales |
|---|---|---|
| (Beginning A/R + Ending A/R) ÷ 2 |
How To Calculate Accounts Receivable Turnover Ratio
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 |
Accounting software like QuickBooks Online lets you run a balance sheet report for the beginning and the end of the period to obtain these numbers. We have a guide and video on how to create a balance sheet report in QuickBooks Online.
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 should exclude 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. Learn more about this report in our article on what a P&L statement is.
Net Credit Sales = Total Sales – Cash Sales – Sales Returns – Sales Allowances
If you’re using QuickBooks, you can check out our guide on how to generate an income statement in QuickBooks Online in a few minutes. To learn more about the platform, our review of QuickBooks Online outlines all of its features that are helpful to small business owners.
Customer purchases paid using credit cards aren’t credit sales—they are cash sales as far as small businesses are concerned. Include credit card sales as cash sales when computing net credit sales.
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 | = | Net Credit Sales (Step 2) |
|---|---|---|
| Average A/R (Step 1) |
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.
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:
| Beginning A/R | $300,000 |
|---|---|
| Add: Ending A/R | $350,000 |
| $650,000 | |
| Divide by 2 (average) | ÷ 2 |
| Average A/R | $325,000 |
The average A/R turnover ratio for ABC Company is calculated as follows:
| Net Sales | $1,300,000 |
|---|---|
| Divide by: Average A/R | ÷ 325,000 |
| A/R Turnover | 4 |
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.
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:
| Beginning A/R | $10,000 |
|---|---|
| Add: Ending A/R | $20,000 |
| $30,000 | |
| Divide by 2 (average) | ÷ 2 |
| Average A/R | $15,000 |
The average A/R turnover ratio for XYZ Company is calculated as follows:
| Net Sales | $100,000 |
|---|---|
| Divide by: Average A/R | ÷ 15,000 |
| A/R Turnover | 6.67 |
An A/R turnover ratio of about 7 means that 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.
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’ ability to collect from its customers. It gives you information about your credit policy and collection process.
| Positive Implications | Negative Implications |
|---|---|
| High A/R Turnover | |
| You collect from customers quickly. | You have a very strict credit granting policy, making it hard for customers to apply for credit purchases. |
| You can liquidate A/R easily. | Your sales are declining and customers are switching over to competitors with more reasonable credit policies. |
| You have a good collection policy that collects all customer accounts on time efficiently. | |
| Low A/R Turnover | |
| Most customers are on a short-term installment agreement. | You don’t religiously remind customers to pay their invoices. |
| You have few but high-value customers. | Your credit granting policy is too relaxed that even customers with bad records are still eligible for credit purchases. |
| The items you sell are slow-moving, high-value goods, such as jewelry and luxury items. | |
Average Accounts Receivable Turnover Ratio by Industry
| Industry | Average A/R Turnover |
|---|---|
| Agriculture, Forestry & Fishing | 9.3 |
| Mining | 8.1 |
| Construction | 6.4 |
| Manufacturing | 6.9 |
| Transportation, Communications, Electric, Gas & Sanitary Services | 8.5 |
| Wholesale Trade | 9.9 |
| Retail Trade | 40.6 |
| Finance, Insurance & Real Estate | 15.9 |
| Services | 6.8 |
| Source: ReadyRatios.com |
The industries above are based on the top-level industry Standard Industrial Classification (SIC) codes. You can use these numbers as broad averages, but we recommend conducting additional research to find the A/R turnover for your industry-level SIC code. You can visit IBISWorld to look for research and data about your industry. In financial ratio analysis, it’s always the rule of thumb to look at industry information. What’s acceptable for a bookkeeping service company may not be acceptable for a photographer.
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:
- 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. Invoicing is an important bookkeeping task. Our article on small business bookkeeping discusses how invoicing plays an integral part in the whole accounting process.
- 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. Our guide on how to ask for a payment via email includes three templates that you can download and customize.
- 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)
What is a good A/R turnover ratio?
A good A/R turnover ratio varies from industry to industry. There is no universal figure that serves as the best A/R turnover ratio. It’s best to always refer to industry averages.
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 A/R 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.
Bottom Line
The A/R turnover ratio tells you how quickly you can collect 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. Read our review of QuickBooks Online to learn more about the solution.
