Introduction
Receivables turnover ratio is a financial metric that measures how efficiently a company collects its accounts receivable. This metric is important because it helps businesses understand how quickly they are turning their accounts receivable into cash. In this article, we will discuss how to find the receivables turnover ratio.
Understanding Receivables Turnover Ratio
Receivables turnover ratio is calculated by dividing net credit sales by average accounts receivable. Net credit sales are the sales made on credit, while average accounts receivable is the average amount of money owed to the company by its customers over a given period of time.
For example, if a company had $500,000 in net credit sales and an average accounts receivable balance of $100,000, the receivables turnover ratio would be 5. This means that the company collects its accounts receivable five times a year.
Calculating Receivables Turnover Ratio
The first step in calculating receivables turnover ratio is to determine the net credit sales for the period you are measuring. This can be found on the company’s income statement.
The next step is to calculate the average accounts receivable balance. This can be done by adding the beginning and ending accounts receivable balances for the period and dividing by 2. For example, if the beginning accounts receivable balance was $80,000 and the ending balance was $120,000, the average accounts receivable balance would be $100,000.
Finally, divide the net credit sales by the average accounts receivable balance. Using the example numbers above, the calculation would be:
Receivables turnover ratio = $500,000 / $100,000 = 5
Interpreting Receivables Turnover Ratio
The higher the receivables turnover ratio, the better. A high ratio indicates that a company is collecting its accounts receivable quickly, which is a positive sign for investors and lenders. It also means that the company has a lower risk of bad debt, as accounts receivable are being paid off in a timely manner.
On the other hand, a low ratio can indicate that a company is having difficulty collecting its accounts receivable. This could be due to a variety of factors, such as poor credit policies or a weak economy.
Using Receivables Turnover Ratio to Make Decisions
Receivables turnover ratio can be used to make important business decisions. For example, if a company has a low ratio, it may need to tighten its credit policies or take more aggressive collection action. If a company has a high ratio, it may be able to offer more generous credit terms to customers or invest in growth opportunities.
Conclusion
Receivables turnover ratio is an important financial metric that measures how efficiently a company collects its accounts receivable. Calculating this ratio is easy and can provide valuable insights into a company’s financial health. By using this ratio to make decisions, businesses can improve their cash flow, reduce their risk of bad debt, and grow their business.
