Receivables Turnover Ratio Meaning
This ratio assesses how well a company manages and uses the credit it gives to consumers, as well as how fast that debt is recovered or paid. A company’s accounts receivable turnover ratio will be higher if it is efficient at collecting its due payments. Comparing a company’s ratio to that of its counterparts in the same industry might help determine whether it is competitive.
Key Takeaways
-The accounts receivable turnover ratio is an accounting metric that determines how effective a company is at recovering receivables by customers.
-A high receivables turnover ratio may suggest that a company’s accounts receivable collection is effective and that the company has a large number of high-quality customers who pay their bills on time.
-Inefficient collection, poor credit policies, or clients that are not financially viable or creditworthy could all contribute to a low receivables turnover percentage.
-The receivables turnover percentage of a corporation should be checked for any trends or patterns.
Receivables Turnover Ratio Formula and Calculation
Accounts Receivable Turnover= Average Accounts Receivable/ Net Credit Sales
What Can The Ratio Tell You?
- Because accounts receivable is money due without interest, companies who keep accounts receivables are implicitly making interest-free loans to their customers. If a corporation makes a transaction to a customer, it may offer 30 or 60-day terms, giving the customer 30 to 60 days to pay for the product.
- The receivables turnover ratio is a metric that indicates how efficiently a company collects on its receivables or lends credit to consumers. On an annual, quarterly, or monthly basis, the receivables turnover ratio is determined.
- The receivables turnover ratio of a company should be examined and studied over time to see whether a trend or pattern emerges. Companies can also track and compare receivables collection to earnings to determine the influence of credit procedures on profitability.
- It’s crucial for investors to examine the accounts receivable turnover ratios of numerous companies in the same industry to obtain a sense of the sector’s usual or average turnover ratio. It may be a secure investment if a firm has a considerably more receivables turnover ratio than the other.
High Receivables Turnover
- A high receivables turnover ratio can suggest that a company’s accounts receivable collection is effective and that the company has a high number of high-quality customers who pay their bills on time. A high receivables turnover ratio could also imply that a business is run on a cash basis.
- A high ratio can also indicate that a business is cautious about offering loans to its clients. A cautious credit policy might be advantageous since it prevents the company from offering credit to customers who may be unable to pay on time.
- On the other side, if a company’s credit policy is overly conservative, potential customers may be turned away. These clients might then do business with competitors who are willing to extend credit to them. If a company is losing customers or growing slowly, it may be beneficial to relax its credit policy to boost sales, even if it means a lower accounts receivable turnover ratio.
Low Receivables Turnover
A low turnover ratio usually indicates that the company’s credit rules need to be reviewed in order to ensure prompt recovery of receivables. If a corporation with a low ratio improves its collection procedure, it may result in a cash infusion from collecting on previous credit or receivables.
Receivables Turnover Ratio’s Limitations
- The receivables turnover ratio, like any other indicator used to assess a company’s efficiency, has its own set of restrictions that any investor should be aware of.
- When estimating their turnover ratio, some organisations, for example, utilise total sales instead of net sales, inflating the figures. While this isn’t always meant to be intentionally deceptive, investors should strive to figure out how a company calculates its ratio or compute it themselves.
- Another drawback of the receivables turnover ratio is that receivables fluctuate a lot throughout the year. In other words, if an investor arbitrarily chooses a starting and ending point for computing the receivables turnover ratio, the ratio may not accurately reflect the company’s ability to issue and collect credit.
- To smooth out any seasonal gaps, investors might use an average of accounts receivable from each month over a twelve month period.
