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When you extend credit to customers, getting paid quickly and consistently is critical to keeping your business healthy. The accounts receivable turnover ratio is one of the most useful metrics for understanding how well your business collects what it’s owed.
Here’s what you need to know about how to calculate it, interpret it, and use it to your advantage.
Key Points
• The accounts receivable turnover ratio measures how efficiently a business collects on credit sales, calculated by dividing net credit sales by average accounts receivable.
• Net credit sales are calculated by subtracting customer returns and discounts from gross credit sales, while average accounts receivable uses the sum of starting and ending balances divided by two.
• Tracking this ratio helps businesses better understand cash flow speed, collection efficiency, customer credit health, and working capital changes that can impact daily operations.
• A high ratio signals strong collections and healthy cash flow, while a low ratio may indicate slow-paying customers or billing inefficiencies requiring attention.
• Offering multiple payment channels, incentivizing early payment with discounts, and comparing results against industry benchmarks provides the most complete picture of collection performance,
What Is the Accounts Receivable Turnover Ratio?
Accounts receivable is the money that your clients or customers owe you for goods or services you’ve already delivered. Your accounts receivable turnover ratio helps you measure how efficiently you’re collecting those debts, essentially turning credit into cash.
The ratio measures how many times in a given period—usually a year—you have been able to successfully collect your average accounts receivable. Understanding this information helps you better understand and monitor your cash flow, working capital, and your ability to collect payment effectively.
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Accounts Receivable Turnover Ratio Formula
To calculate your accounts receivable turnover ratio, you’ll need to do a little bit of math and have two important pieces of information handy: your net credit sales and your average accounts receivable.
How to Calculate Average Accounts Receivable
The accounts receivable turnover ratio formula is:
Accounts receivable turnover ratio = Net credit sales / average accounts receivable
Net credit sales is the revenue your company earns based on credit. Calculate this by subtracting customer returns and discounts from gross credit sales.
Your average accounts receivable is the typical amount of outstanding customer payments over a given period of time, such as a year. To calculate this, you’ll take the sum of starting and ending accounts receivable over a time period and divide by two.
For example:
Say a company has the following figures for the year:
Net credit sales: $1,200,000
Beginning AR: $150,000
Ending AR: $250,000
First calculate average accounts receivable:
(150,000 + 250,000) Ă· 2 = $200,000
Next, calculate the accounts receivable turnover ratio:
$1,200,000 Ă· $200,000 = 6
How to Interpret Your AR Turnover Ratio
Once you’ve got your accounts receivable turnover ratio in hand, what do you do with it? For one, you can use it to figure out your days sales outstanding. While your accounts receivable turnover ratio measures how many times your business collects its average customer balances over a year, days sales outstanding tells you how many days it takes to collect those payments.
You can calculate days sales outstanding by dividing the number of days in a year by the ratio you found.
In the above example, the accounts receivable turnover ratio was 6:
365/6= 60.8
In other words, you are able to collect your accounts receivable 6 times a year or about every 61 days.
These figures can clue you in to important business information, such as cash flow speed, collection efficiency, customer credit health, and changes to your working capital that can impact operations.
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Accounts Receivable Turnover Ratio by Industry
So how do you know if your accounts receivable turnover ratio is good or not? One way is to benchmark it against industry standards to get a sense of your company’s performance.
Ratios vary widely by industry. For example, agricultural services companies might have a relatively low ratio, around four on average. Meanwhile, general contractors for building construction have an average of 58, meaning their collecting account receivable more frequently than once a week.
How to Improve Your Accounts Receivable Turnover Ratio
Improving your accounts receivable turnover ratio means collecting your accounts receivable more frequently.
One way to accomplish this is by reducing the payment term you offer to clients. Also, be sure that you bill them immediately for the work you’ve done. For instance, send invoices on the same day that goods or services are delivered. Then schedule automatic payment reminders for a few days before and right on the payment due date. Have clear protocols for what to do when a client is late.
Do what you can to make payment convenient. That could mean offering multiple payment channels, such as credit cards, digital wallets, or ACH payments. You might also consider incentivizing early payment with a small discount and disincentivizing late payments with penalties.
Limitations of the Accounts Receivable Turnover Ratio
Your accounts receivable turnover ratio can tell you a lot, but it can’t tell you everything. One reason is that it’s an average, so it doesn’t provide much granular information. For instance, it doesn’t tell you if a particular client tends not to pay on time. Especially if this is a large client, it can really skew your results.
The ratio also doesn’t account for seasonality. If your business makes more in the winter than in the summer, for instance, your ratio will be skewed as well.
In and of itself, the ratio also doesn’t take industry norms into account. This is why it’s so important to benchmark your ratio against industry standards. That way, you can get a better idea of whether you’re operating normally or if there might be any issues you need to look into more.
For instance, if you’re collecting payments too frequently for your industry, it may be that your payment standards are too strict. You could be scaring away potential customers.
The Takeaway
The accounts receivable turnover ratio is a powerful measure of your business’s financial health. A high ratio signals strong collections and healthy cash flow, while a low ratio may point to slow-paying customers or billing inefficiencies.
Context matters. Always compare your ratio against industry benchmarks, consider factors such as seasonal fluctuations, and pair it with other metrics like days sales outstanding for a fuller picture of your cash flow and working capital cycle. That context will help you determine what, if anything, needs to change.
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FAQ
What is a good accounts receivable turnover ratio?
Normal accounts receivable turnover ratios vary by industry. Look online for industry averages to see how your business lines up.
How does the AR turnover ratio relate to days sales outstanding?
The accounts receivable turnover ratio is a measure of how many times you collect your average customer balance over a given period, generally a year. Days sales outstanding measures how many days it takes to collect those payments. You can calculate it by taking the number of days in the period and dividing it by the accounts receivable turnover ratio.
What causes a low AR turnover ratio?
A low accounts receivable turnover ratio is a result of collecting payments too infrequently. This could be caused by clients who don’t pay on time. Or it could be caused by an internal problem, such as slow invoicing times.
How does accounts receivable turnover affect cash flow?
High accounts receivable turnover tends to me that you collect payments quickly and your cash flow is strong. Low accounts receivable turnover often means that customers are taking a long time to pay you and this may mean your cash flow is weak, and you may need to rely on tools such as a business line of credit to keep operating smoothly.
What is the difference between accounts receivable turnover and accounts payable turnover?
Confused about the difference between accounts payable vs. accounts receivable? Accounts payable turnover is a measure of how fast you pay your suppliers. It represents the rate at which money is going out, while accounts receivable turnover is the rate at which money is flowing in.
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