Accounts receivable turnover ratio (ART) is calculated by dividing net sales by the average accounts receivable. It’s also known as the debtor’s turnover ratio.
Many financial analysts prefer to take credit sales in place of total sales. However, in the income statement, companies do not report credit sales figures, therefore total sales can be considered in absence of credit sales.
Here is the formula to calculate accounts receivable turnover ratio;
Accounts receivable turnover = Net Sales / Average accounts receivable
Net sales = sales – returns – allowances
Average accounts receivable = (beginning accounts receivable + ending accounts receivable) / 2
Both opening and closing accounts receivable can be obtained from company’s balance sheet.
Example: How to calculate accounts receivable turnover ratio
The company has a total sales of Rs 8,00,000. On 1st of april 2021, beginning debtors was Rs 3,00,000 and on 31st march 2022 ending debtors was Rs 5,00,000.
Based on above details here is the calculation of ART ratio;
Average accounts receivable = (3,00,000+5,00,000)/2 = Rs 4,00,000
Total sales = Rs 8,00,000
ART ratio = Rs 8,00,000 / Rs 4,00,000 = 2
Therefore, the company collects its average debtors approximately 2 times over the financial year.
What accounts receivable turnover ratio tells you
Accounts receivable turnover ratio indicates how effectively the company collects credit from its customers
Higher accounts receivable turnover ratio tells you that the company is very efficient in collecting money as it indicates a shorter delay between credit sales and cash received.
In contrast, a lower accounts receivable turnover ratio indicates longer time between credit sales and cash receipts. It indicates either the company has a very lenient credit policy or they have poor quality of debtors.
High ratio also indicates that the company might be dealing in cash sales or has a very strict credit policy. This might be a disadvantage as customers might move to competitors offering better credit facilities.
To get a clear picture on higher or low accounts receivable turnover ratio, it’s better to compare with immediate competitors within the same industry.
Also Read: Accounts Payable turnover ratio: Calculation and what it tells you
