The accounts receivable turnover ratio measures how effectively a business can collect payment from customers they have extended credit to. The ratio shows how effective their credit policy and procedures are and how streamlined their accounts receivable process is. This article shows you how to calculate your A/R turnover ratio and what it means.
What the Accounts Receivable Turnover Ratio Is
The accounts receivable (A/R) turnover ratio is the number of times a business collects its average accounts receivable balance within a given period of time, generally one year. The A/R turnover ratio is calculated by taking the net credit sales and dividing that number by the average accounts receivable balance.
The Accounts receivable turnover ratio formula is:
Net Credit Sales / (Beginning accounts receivable + Ending accounts receivable) / 2)
How to Calculate Accounts Receivable Turnover Ratio
You can calculate the accounts receivable turnover ratio in three easy steps. First, you need to calculate the average accounts receivable balance. Next, you identity your net sales, which should be reduced by any product returns and allowances. Finally, you take your net credit sales and divide it by the average accounts receivable balance.
Follow these steps to calculate the accounts receivable turnover ratio:
1. Calculate Average Accounts Receivable
The average accounts receivable is the balance owed by customers in a given period of time. The average accounts receivable balance is calculated by adding the accounts receivable balances at the start and end of the period and dividing that total by two. Accounting software like QuickBooks lets you run a balance sheet report for the beginning of the period and the end of the period to obtain these numbers.
(Beginning accounts receivable + Ending accounts receivable) / 2 = Average Accounts Receivable
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 not include any product returns, allowances, or cash sales. You can obtain this information from your profit and loss report, also known as the income statement. If you use accounting software like QuickBooks, you can generate a QuickBooks income statement in a few minutes.
Sales on Credit – Sales Returns – Sales Allowances = Net Credit Sales
3. Divide Net Credit Sales by Average Accounts Receivable
After calculating the average accounts receivable balance and obtaining the net credit sales for the period, you can calculate the accounts receivable turnover ratio. To calculate the A/R turnover ratio, take the net credit sales and divide it by the average accounts receivable balance. The result is your accounts receivable turnover ratio.
Net Credit Sales / Average Accounts Receivable = Average Accounts Receivable
How to Interpret the Accounts Receivable Turnover Ratio
Now that you have your A/R turnover ratio, what does it mean? Your A/R turnover ratio gives you information about your credit policy and collection process. A high A/R turnover ratio indicates you have a strict credit policy and a solid collections process in place to ensure prompt payments.
On the other hand, a low A/R turnover ratio could mean your credit policy is too loose or maybe even nonexistent. It could also mean you need a more streamlined accounts receivable process that includes promptly invoicing customers and sending payment reminders before invoices become due.
Similar to other financial ratios, the accounts receivable turnover ratio is only one piece of information about a business’ ability to collect from their customers. Whichever way your A/R ratio is trending, you will need to do some additional research to find out the cause. For example, a very high A/R turnover ratio could mean your credit policy is too strict and causing lost sales because customers who don’t meet your criteria choose a competitor with a more flexible credit policy.
Part of your analysis of your A/R turnover ratio trend should be finding out what the average A/R turnover ratio is for your industry. What’s acceptable for a bookkeeping service company may not be acceptable for a photographer. Find out the average accounts receivable ratio for your industry and compare it to yours to see how you match up.
Accounts Receivable Turnover Ratio Examples
In order for you to have a good grasp on how to calculate the A/R turnover ratio, we have provided a couple of examples using two fictitious companies. These examples should also give you an idea of what’s considered a high turnover ratio and what’s considered a low turnover ratio.
Below are two examples of how to calculate the accounts receivable turnover ratio:
Accounts Receivable Turnover Ratio for ABC Company
ABC Company had the following results last year:
- Net credit sales were $1,300,000
- Accounts receivable were $300,000 at the beginning of the year and $350,000 at the end of the year
The average accounts receivable 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:
$1,300,000 Net Sales / $325,000 Average A/R Balance = 4
An accounts receivable turnover ratio of 4 means ABC Company was able to collect its average accounts receivable balance ($325,000) about four times throughout the year.
Accounts Receivable Turnover Ratio for XYZ Company
XYZ Company had the following results in the first six months:
- Net credit sales was $100,000
- Accounts receivable was $10,000 at the beginning of the year and $20,000 at the end of the year
The average accounts receivable 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 = 6.67
An accounts receivable turnover ratio of 7 means XYZ Company was able to collect its average accounts receivable balance ($15,000) about seven times throughout the year.
Ways to Improve Your Accounts Receivable Turnover Ratio
After calculating your accounts receivable 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 accounts receivable turnover. Many businesses improve their efficiency with prompt invoices, timely reminder emails, and online payment options.
Three ways you can improve your accounts receivable turnover ratio are:
- Promptly invoice customers: 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 accounts receivable 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 and a simple reminder can go a long way to ensure you receive payment on time.
- Accept online payments: Give customers the option to pay their invoices online. Accounting software like QuickBooks allows you to email invoices to customers that include a payment link. Customers simply click on the link, enter payment details, and submit their payment.
Reports to Help You Compute Accounts Receivables Turnover Ratio
In order to calculate your accounts receivable turnover ratio, you need to access your total net sales and the average accounts receivable balance. If you use an accounting software like QuickBooks, you can get this information from two reports: the balance sheet report and the profit and loss (income statement) report.
Below are the steps you need to follow to generate the reports you need from QuickBooks:
Generating Profit & Loss Reports in QuickBooks Online
The profit and loss report, or income statement, summarizes the income and expenses for a company over a period of time (e.g., monthly, quarterly, annually). You can run this report by navigating to the reports center. Within the business overview section, you will see a link to the profit and loss report. You have the option of running a detailed or a summarized report.
Follow the steps below to generate a profit and loss report in QuickBooks Online:
1. Navigate to the Report Center in QuickBooks Online
From the left menu bar, click on the Reports tab, as indicated below:
2. Select the Profit & Loss Report in QuickBooks Online
You will see several profit and loss reports in the business overview section. We can run the summary version of the profit and loss statement.
Click on the Profit and Loss report, as indicated below:
3. Select the Date Range & Generate the Report
After clicking on profit and loss, the report will displays. The net sales figure, also referred to as total income, is the first subtotal that appears on the report.
In the profit and loss report below, the total income (net sales) figure is $449,657 for the period January through December 2022:
Generating a Balance Sheet Report in QuickBooks Online
The balance sheet report summarizes the assets, liabilities, and equity for a business at a specific point in time (e.g., January 1). To generate this report in QuickBooks, navigate to the Report Center. In the business overview section, you will see several balance sheet reports.
1. Navigate to the Report Center
On the left menu bar, click on the Reports tab, as indicated below:
2. Generate the Balance Sheet Report in QuickBooks Online
You will see several balance sheet reports in the business overview section. Select the balance sheet summary report, as indicated below:
3. Generate Balance Sheet Report, Beginning of the Year
The balance sheet report displays once you select Balance Sheet Summary from the menu. Run the report for January 1 of the year you are working on. The accounts receivable balance as of the beginning of the year will be located within the assets section of the report at the very top.
In the balance sheet report below, the accounts receivable balance as of January 1, 2022, is $21,249:
4. Generate Balance Sheet Report, End of the Year
Change the report date to December 31, 2022. This gives us the accounts receivable balance at the end of the year.
In the balance sheet report below, the accounts receivable balance as of December 31, 2022, is $93,008:
Accounts Receivable Turnover Ratio Calculation
Below is the A/R turnover ratio calculated using the figures in the profit and loss and balance sheet reports from QuickBooks:
Net Credit Sales / (Beginning accounts receivable + Ending accounts receivable) / 2
$449,657 / ($21,249 + $93,008) / 2 = 3.93 (round up to 4)
An accounts receivable turnover ratio of 4 indicates that the average accounts receivable balance has been collected about four times between January 1 and December 31, 2022.
Free Accounts Receivable Turnover Ratio Template
Download this free accounts receivable turnover ratio template to quickly calculate your A/R turnover. Plug your net sales and average A/R balance numbers into the template, and your A/R ratio will automatically calculate for you.
Accounts Receivable Turnover Ratio vs Accounts Payable Turnover Ratio
The accounts payable turnover ratio is the complete opposite of the accounts receivable ratio. It measures how quickly a business pays its bills, whereas the accounts receivable turnover ratio measures how quickly a business can collect payment from customers they have extended credit to.
Like the accounts receivable turnover ratio, a higher accounts payable turnover ratio is typically good. It indicates the business pays their vendor suppliers on time. A low A/P turnover ratio may indicate a business is not paying their bills on time. This could lead your suppliers to decrease the amount of credit they extend to you or to remove credit terms altogether. To stay on top of unpaid bills, you should review your accounts payable aging report often and submit your payments on time.
Pros & Cons of the Accounts Receivable Turnover Ratio
There are pros and cons to using the accounts receivable turnover ratio. On the pro side, it can help you to forecast your cash flow, identify and address customer payment issues, and determine the effectiveness of your credit policy. On the con side, you must review the ratio on a consistent basis (e.g., monthly, quarterly, annually), invest the time to investigate further, and avoid comparing yourself to companies outside of your industry.
The pros and cons of using the A/R turnover ratio are:
Pros of Using the A/R Turnover Ratio
The pros of using the AR turnover ratio are:
- Helps you forecast cash flow: Being aware of how often customers make their payments helps you to plan and manage paying your expenses and meeting your payment obligations to your vendor suppliers.
- Shines a light on internal the billing department issues: As previously mentioned, a low A/R turnover ratio could indicate customers are not paying their invoices on time. However, other factors could also be in play. For example, the billing department could be behind on sending invoices out on time. If you’ve already streamlined your A/R processes, the solution might be to hire another person to assist with the workload.
- Aids in assessing the effectiveness of current credit policy: If your A/R turnover is trending very high or very low, it could indicate an issue with your credit policy and procedures. An extremely high A/R turnover ratio could indicate that your requirements for extending credit are too high. This could lead to the denial of credit for customers who missed the mark because of a business credit score that was only a few points off.
Cons of Using the A/R Turnover Ratio
The cons of using the AR turnover ratio are:
- Needs regular review: You should take a look at your A/R turnover ratio each time financial statements are generated. Most small businesses generate financial statements on an annual basis. Be sure to do a year-over-year comparison to see if you are trending up or down compared to the previous year. If you’re trending down, you will need to do some further analysis, such as looking at the ratio on a quarterly basis.
- Requires further analysis: As mentioned previously, you cannot take your A/R turnover ratio and make decisions solely based on that number. Further analysis is needed to determine why you are trending up or down.
- Does not allow comparison outside of industry: Comparing your A/R turnover ratio to a company in a completely different industry is like comparing apples to oranges. The litmus test is to compare your A/R turnover to similar businesses within your industry. Each industry has its own unique traits and those must be taken into account when looking at liquidity ratios such as the A/R turnover ratio.
Frequently Asked Questions (FAQs) About Accounts Receivable Turnover Ratio
We have included the most frequently asked questions about accounts receivable turnover in this section. If you don’t see your question, you can visit the Fit Small Business forum and post your question there. One of our industry experts will respond to your question.
The most frequently asked questions about accounts receivable turnover ratio are:
How do you calculate the accounts receivable turnover?
To calculate the accounts receivable turnover, you first need to find the average accounts receivable balance. This is done by adding the beginning and ending accounts receivable 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 accounts receivable balance.
What is a good accounts receivable turnover?
The accounts receivable turnover measures the number of times a company collects their average accounts receivable balance over a period of time. In general, the higher the accounts receivable turnover, the better. For example, an A/R turnover ratio of 15 is better than 10. An A/R ratio of 15 means the business is collecting their A/R balance about 15 times throughout the year.
Does accounts receivable turnover include allowance for doubtful accounts?
The accounts receivable turnover is calculated using net sales. To calculate net sales, you take gross sales and reduce it for product returns, discounts, and allowances (also known as the allowance for doubtful accounts), which are accounts that could potentially become bad debt. The result is net sales.
To recap, the accounts receivable turnover ratio tells you how quickly you are collecting on the money owed to you by customers to whom you have granted credit privileges. It also provides insight into your credit policy and whether or not you need to improve upon your existing accounts receivable process and procedures. If you use accounting software like QuickBooks, you can quickly run the reports you need to calculate your A/R turnover ratio.
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