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Overview of Receivables Turnover Ratio
Definition of
Receivables Turnover Ratio
What is the Receivables Turnover Ratio? The Receivables Turnover Ratio, also known as the Accounts Receivable Turnover Ratio, is an efficiency ratio that measures how many times a company collects its average accounts receivable balance during a specific accounting period. It indicates how effectively a company is managing the credit it extends to customers and how quickly that credit is converted into cash. The formula is: Receivables Turnover Ratio = Net Credit Sales / Average Accounts Receivable. Average Accounts Receivable is often calculated as (Beginning Accounts Receivable + Ending Accounts Receivable) / 2.
Activities Related to
Receivables Turnover Ratio
Here is a list of Receivables Turnover Ratio related activities:Â Calculating net credit sales for a period (total credit sales less sales returns and allowances), Determining the average accounts receivable for the same period, Applying the ratio formula, Analyzing the efficiency of the company's credit and collection policies, Comparing the ratio to industry averages or past performance, Using the ratio to calculate Days Sales Outstanding (DSO) to see the average collection period in days, and Making decisions to improve collection processes if the turnover is low.
The Importance of
Receivables Turnover Ratio
The Receivables Turnover Ratio is important because it indicates how efficiently a company uses its assets and manages its credit policies. A high ratio generally suggests that the company is effective in collecting its receivables quickly, which means it has a strong cash flow and may have a conservative credit policy. A low ratio might indicate problems with the collection process, overly lenient credit terms, or customers who are not paying on time, which can lead to bad debt expense and liquidity issues. Monitoring this ratio helps businesses optimize their working capital.
Key Aspects of
Receivables Turnover Ratio
Efficiency Measure
Indicates how many times, on average, a company collects its outstanding receivables during a period.
Liquidity Indicator
A higher ratio suggests better liquidity, as receivables are quickly converted to cash.
Uses Net Credit Sales
The numerator should ideally be net credit sales, as cash sales do not create receivables.
Interpretation Context
A "good" ratio varies by industry; it should be compared to industry benchmarks and the company's own historical trends.
Concepts Related to
Receivables Turnover Ratio
The Receivables Turnover Ratio is one of several Liquidity Ratios and efficiency ratios used in Financial Statement Analysis. It is closely related to Accounts Receivable (a current asset on the Balance Sheet) and Net Credit Sales (from the Income Statement). It can be used to calculate Days Sales Outstanding (DSO), which indicates the average number of days it takes to collect receivables.
Receivables Turnover Ratio
in Action:
The Adventures of Coco and Cami
Coco and Cami offer some of their regular corporate clients the option to pay later for large catering orders. They want to know how quickly they're collecting that money.
Professor A introduces the Receivables Turnover Ratio, explaining how this calculation helps them see how efficiently they are collecting payments owed by customers, which is vital for their cash flow.