Accounts receivable turnover
How is accounts receivable turnover calculated?
Accounts receivable turnover is calculated by dividing the net sales by the average accounts receivable for that period. It can be expressed in any of the following ways:
Accounts receivable turnover = net sales / average accounts receivable
Accounts receivable turnover = net sales / (start of period accounts receivables + end of period accounts receivable) / 2
Accounts receivable turnover = 2 * net sales / (start of period accounts receivables + end of period accounts receivable)
In example number two and three the average of the start and end of period receivables are used as an estimate for the average accounts receivables. The logic behind the number is if your sales in a period is $20 but your average outstanding receivables is only $10, then you must have collected your average amount of invoice twice.
Why is accounts receivable turnover important?
- It is an indication of a company's efficiency in debt collecting
- It is an indication of the quality of a company's sales, customers and the customers reliability.
- A low ratio improves a company's cash flow and a high ratio decreases it.
- It can be an indication of a company's strength in the value chain and in its relationship with its customers because most probably the more pull the company has, the more favorable credit terms it will have in agreements.
- A high ratio driven by extending favorable credit terms to customers might be a way to gain market share.
- The trend of the ratio can give an indication of future cash flow