How do you calculate the accounts receivable turnover ratio from financial statements?
Learn the formula and steps to calculate the accounts receivable turnover ratio using financial statements to assess how efficiently a company collects receivables.
The accounts receivable turnover ratio measures how efficiently a company manages its accounts receivable by showing how many times, on average, it collects outstanding receivables during a specific period. To calculate the accounts receivable turnover ratio from financial statements, you'll need information from both the income statement and the balance sheet. Here's the formula and the steps to calculate it:
Accounts Receivable Turnover Ratio Formula:
Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Step 1: Calculate Net Credit Sales:
- Review the income statement (also known as the statement of comprehensive income or statement of operations) to find the net credit sales figure. Net credit sales represent the total sales made on credit, excluding sales made for cash or other payment methods.
Step 2: Calculate Average Accounts Receivable:
- You'll need the accounts receivable balances at the beginning and end of the period. You can find these figures on the balance sheet (also known as the statement of financial position).
- Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2
Step 3: Calculate the Ratio:
- Use the values obtained in Steps 1 and 2 to calculate the accounts receivable turnover ratio.
- Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Step 4: Interpret the Ratio:
- A higher accounts receivable turnover ratio indicates that the company is collecting its receivables more efficiently, which is generally favorable.
- A lower ratio may suggest that the company is having difficulty collecting payments from customers or has a high level of outstanding receivables, which can be a concern.
Example:Suppose a company has net credit sales of $500,000 during the year. At the beginning of the year, its accounts receivable balance was $50,000, and at the end of the year, it was $60,000.
Average Accounts Receivable = ($50,000 + $60,000) / 2 = $55,000
Accounts Receivable Turnover = $500,000 / $55,000 = 9.09
In this example, the accounts receivable turnover ratio is 9.09 times, meaning the company collects its outstanding receivables approximately nine times a year, on average.
Keep in mind that industry norms and benchmarks can vary, so it's essential to compare the accounts receivable turnover ratio to those of similar companies in the same industry to assess how efficiently your company is managing its receivables. Additionally, trends in the ratio over time can provide valuable insights into a company's financial performance and collection practices.
Calculating the Accounts Receivable Turnover Ratio for Receivables Management.
The accounts receivable turnover ratio is a financial ratio that measures how quickly a company collects its accounts receivable. It is calculated by dividing net credit sales by average accounts receivable.
Net credit sales is the total amount of sales that a company makes on credit, minus any sales returns or allowances.
Average accounts receivable is the average balance of accounts receivable over a period of time, such as a month, quarter, or year. It is calculated by adding the beginning and ending accounts receivable balances and dividing by two.
Accounts receivable turnover ratio = Net credit sales / Average accounts receivable
A higher accounts receivable turnover ratio indicates that a company is collecting its accounts receivable more quickly. A lower accounts receivable turnover ratio indicates that a company is taking longer to collect its accounts receivable.
Example:
A company has net credit sales of $1,000,000 and average accounts receivable of $200,000. Its accounts receivable turnover ratio is 5.0.
This means that the company collects its accounts receivable an average of 5 times per year.
Receivables Management
The accounts receivable turnover ratio is an important tool for receivables management. Receivables management is the process of collecting accounts receivable in a timely manner. By monitoring the accounts receivable turnover ratio, companies can identify any potential problems with their receivables collection process and take steps to address them.
Here are some ways to improve the accounts receivable turnover ratio:
- Offer early payment discounts.
- Send regular statements and invoices to customers.
- Follow up with customers promptly on overdue payments.
- Use a credit scoring system to assess customer creditworthiness.
- Implement a collections policy and procedures.
By improving the accounts receivable turnover ratio, companies can reduce their risk of bad debt and improve their cash flow.