In the world of accounting, there are so many terms and ratios that it is easy to get confused. The accounts receivable turnover ratio is one ratio that you will want to become familiar with because it is used often in the business world. It is an important business measure that requires you to have a good understanding of your accounts receivable.
In this article, we will be discussing everything you need to know about the accounts receivable turnover ratio. This includes the formula, definition, and an example to help you better understand how this ratio works.
What is the Accounts Receivable Turnover Ratio
The accounts receivable turnover ratio is a solvency ratio that measures a company’s ability to collect its receivables promptly. In other words, it tells you how quickly and efficiently a company is collecting its money.
This ratio is important because it allows creditors and investors to see how well a company is managing its receivables. A high turnover ratio indicates that a company is collecting its receivables quickly and efficiently. A low turnover ratio, on the other hand, could indicate that the company is having trouble collecting its receivables.
It’s also important for businesses because it helps them keep track of how much money is tied up in receivables. The sooner a company can collect its receivables, the better because that means it has more cash on hand to reinvest in the business or pay off debts.
Accounts Receivable Turnover Ratio formula
Now that we know what the accounts receivable turnover ratio is, let’s take a look at how it’s calculated. The formula for this ratio is relatively simple and is as follows:
Net Credit Sales / Average Accounts Receivable = Accounts Receivable Turnover Ratio
Net credit sales: This is the total sales made on credit over some time. It is the amount of revenue that a company has generated after deducting any returns or discounts.
Average accounts receivable: This is the average amount of receivables that a company has outstanding during a period. To calculate this, you simply take the beginning and ending receivables for the period and divide them by two.
Examples
So now that we know the formula, let’s take a look at an example to see how this ratio works in practice.
Let’s say that Company ABC has net credit sales of $100,000 for the year. Additionally, its beginning receivables were $10,000 and its ending receivables were $15,000. Using the formula above, we can calculate the accounts receivable turnover ratio as follows:
Accounts Receivable Turnover Ratio = $100,000 / {($10,000 + $15,000) / 2}
Accounts Receivable Turnover Ratio = $100,000 / $12,500
Accounts Receivable Turnover Ratio = 8
This means that Company ABC is collecting its receivables 8 times per year on average. This is a relatively high turnover ratio and indicates that the company is efficient in collecting its money.
Conclusion
So there you have it. This is everything you need to know about the accounts receivable turnover ratio. By now, you should have a good understanding of what this ratio is, how it’s calculated, and what it means for businesses. Thanks for reading.
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