Calculating Accounts Receivable Turnover to Improve Your A/R Ratio
Calculating Accounts Receivable Turnover to Improve Your A/R Ratio
As the economy continues to fluctuate, finance teams need to have a clear and complete picture of their organization's cash flow now more than ever. Understanding accounts receivable turnover is critical in today's business environment because it provides valuable insight into a company's financial health and ability to collect on outstanding debts.
Discover why it’s important to calculate accounts receivable turnover, compare the results against industry benchmarks and how to improve your accounts receivable turnover ratio with the help of automation tools.
What is Accounts Receivable Turnover
Accounts receivable turnover measures a company's ability to collect payments from its customers. It’s a key indicator of a company’s performance and overall success. Closely monitoring your turnover ratio is essential for tracking the financial health of your business.
When it comes to understanding the working capital profile of a business, calculating the accounts receivable turnover is an important step in the process. It shows how quickly a company is able to collect payments from customers and how it can be used to assess the financial health of a business.
A high accounts receivable turnover rate suggests that a business is effectively managing its customer credit and collections processes. It means that customers are paying their invoices in a timely manner, which allows the business to collect enough cash to cover operating costs. A low accounts receivable turnover, can be a sign of poor customer service, a lack of payment terms, or bad debt that is not being collected.
How Do You Calculate Turnover Ratio?
Accounts receivable turnover is calculated by dividing the total net credit sales for the period by the average accounts receivable balance. The formula is as follows:
Accounts receivable turnover = Total Net Credit Sales / Average Accounts Receivable Balance
In this equation, “Total Net Credit Sales” can be found on the income statement and “Average Accounts Receivable Balance” can be found on the balance sheet.
For example, a company had net credit sales of $1,000,000 and an average accounts receivable of $200,000. The accounts receivable turnover would be:
Accounts Receivable Turnover = $1,000,000 / $200,000 = 5x
AR Turnover Industry benchmarks
Source: CSI Market - Receivable Turnover Ratio Screening as of Q3 of 2022
The Impact of Low Accounts Receivable Turnover
A low accounts receivable turnover can have serious financial consequences for a company.
Some include:
Increased administrative costs: A low accounts receivable turnover means that businesses have to spend more time and resources chasing late payments, resulting in increased administrative costs.
Lost profits: Late payments can cause delays in production, resulting in lost profits.
Bad debt: If customers are unable to pay their invoices, then the business may have to write off the debt.
Creditworthiness: Low accounts receivable turnover can negatively affect a business’s creditworthiness, making it more difficult to access credit in the future.
5 Tips to Improve Your Accounts Receivable Turnover Ratio
There are a few ways to improve your accounts receivable turnover ratio. The most effective include:
Offer discounts to customers who pay early.
Use automated reminders to ensure invoices are paid on time.
Negotiate payment terms with customers.
Monitor customer creditworthiness.
Invest in accounts receivable automation tools.
Modernizing Accounts Receivable Automation Tools
Accounts receivable automation tools help businesses streamline their accounts receivable processes. These tools automate tasks such as invoicing, payments, collections, and reporting. Automating these processes saves time and money, while also improving accuracy and customer satisfaction.
Using AR Automation Tools to Manage Turnover Ratio
Accounts receivable turnover is a key indicator of a business’s financial health, and it’s important to calculate and monitor it. By understanding your accounts receivable turnover, you’ll be able to identify any problems and take action to improve it. To improve your turnover ratio, you can offer discounts to customers who pay early, negotiate payment terms, monitor customer creditworthiness, and invest in accounts receivable automation tools. Low accounts receivable turnover can have serious financial consequences, so it’s important to ensure that you’re managing it effectively.
Key Takeaways:
Accounts receivable turnover is a metric used to measure a company’s ability to collect payments from their customers.
It is important to calculate and monitor accounts receivable turnover to assess the financial health of a business.
Offering discounts to customers who pay early, negotiating payment terms, monitoring customer creditworthiness, and investing in accounts receivable automation tools are all ways to improve accounts receivable turnover.
Low accounts receivable turnover can have serious financial consequences, such as increased administrative costs, lost profits, and bad debt.
