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Receivables turnover ratio

Receivables turnover ratio

Receivables turnover ratio is a calculation used in accounting. Its main function is to measure how effective a company is in extending its credit and collecting debts.

Key takeaways:

  • The receivables turnover ratio is a financial metric used to assess how efficiently a company manages its accounts receivable.
  • The receivables turnover ratio is calculated by dividing net credit sales by the average accounts receivable during a specific period.
  • A high receivables turnover ratio indicates that a company collects its receivables quickly, which is generally a positive sign of effective credit management.
  • Conversely, a low receivables turnover ratio suggests that a company takes longer to collect payments, which can be a potential indicator of credit collection issues or ineffective credit policies.

Where have you heard of receivables turnover ratio?

You might have heard of it being called the debtor’s turnover ratio. It’s widely used in business to measure how efficiently a company is using its assets.

Receivables turnover ratio formula

The formula for calculating the receivables turnover ratio:

Receivables Turnover Ratio = Net Credit Sales / Average Accounts Receivable

To calculate the receivables turnover ratio, you need to determine the net credit sales and the average accounts receivable.

Net Credit Sales: This refers to the total amount of sales made on credit during a specific period, minus any returns, allowances, or discounts.

Average Accounts Receivable: This is calculated by adding the beginning and ending accounts receivable balances for a given period and dividing the sum by 2.

Once you have these two values, you can divide net credit sales by the average accounts receivable to obtain the receivables turnover ratio.

What you need to know about receivables turnover ratio

It’s usually worked out on an annual basis, but this can also be broken down to produce a monthly or quarterly figure. To calculate the receivables turnover ratio, accountants divide the net value of credit sales during a set period by the average accounts receivable during the same period. Once it’s been calculated, this ratio shows how efficiently a firm manages the credit it has issued to its customers and collects on that credit.

Example of receivables turnover ratio

  1. Net Credit Sales: X Inc. had net credit sales of $500,000 during 2022.

  2. Accounts Receivable: At the beginning of 2022, X Inc. had accounts receivable of $100,000, and at the end of 2022, it had accounts receivable of $80,000.

  3. Average Accounts Receivable: To calculate the average accounts receivable, we add the beginning and ending accounts receivable and divide by 2: Average Accounts Receivable = ($100,000 + $80,000) / 2 = $90,000

  4. Receivables Turnover Ratio: Now we can calculate the receivables turnover ratio using the formula: Receivables Turnover Ratio = Net Credit Sales / Average Accounts Receivable Receivables Turnover Ratio = $500,000 / $90,000 ≈ 5.56

Therefore, the receivables turnover ratio for X Inc. in 2022 is approximately 5.56. This means that, on average, X Inc. collected its accounts receivable 5.56 times during the year.

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