Understanding Account Receivable Turnover Ratios
Account Receivable Turnover Ratio measures the number of times a company collects its receivables. This ratio indicates how well the company accumulates its due receivables. A company's account receivables refer to the credit it has given to its customers, and its turnover refers to how it converts that credit into cash. It is calculated as Net Sales divided by Average Account Receivables.
The formula to derive Account Receivable Turnover Ratio
Net Sales - It is the amount of total revenue after deduction of the cost of sales returns, allowances, and discounts.
Average Account Receivables - It is the sum of starting and ending accounts receivable during a period divided by two.
Example of Account Receivable Turnover Ratio: For the financial year, Maruti Suzuki India reported net sales as Rs. 70372 Cr., and Average Account Receivable as Rs. 2709.50 Cr.,
The value as per the formula (Net Sales / Average Account Receivable) is calculated as (70372 / 2709.50) = 26.02.
Key Highlights
The account receivable turnover ratio indicates how well the company accumulates its due receivables.
The account receivable turnover ratio is calculated as net sales divided by average accounts receivables.
This ratio depends on the industry as it changes from one industry to another as the period of collection is different for every business.
While looking at the Account Receivable Turnover Ratio, the following points should also take into consideration:
A higher account receivable turnover ratio is considered good. It indicates that the company is efficient in receiving its payment more quickly in a financial year. It also signifies that the company may have strict credit policies. If the company's account receivable ratio is 4, then it shows that the company is receiving its credit payment four times in the financial period.
A low account receivable ratio indicates that the company is receiving its payment slowly. But it does not mean it is bad in all cases as it can be due to the company's policies or other factors.
This ratio depends on the industry as it changes from one industry to another as the period of collection is different for every business.
If we divide 365 days by account receivable turnover ratio, we get the period of account receivable days. It indicates how many days a company takes to receive its payments.
How to use Account Receivable Turnover Ratio effectively
While doing relative analysis, compare companies that operate in the same industry, because depending upon the industry, some companies may take 60 days and some others may take 6-7 months.
By dividing 365 days by account receivable turnover ratio, we get account receivable days, which shows how many days a company requires to settle the invoices. So account receivable days go better along with the account receivable turnover ratio at the time of analysis.
For better analysis, we cannot depend on one particular ratio. So use other metrics with account receivable turnover ratio like
Inventory Days,
Account Receivable Days,
Cash Ratio, etc.,
