As a business owner, you know that managing your finances is crucial to the success of your company. One important aspect of financial management is understanding your accounts receivable turnover ratio. This ratio can provide valuable insights into your sales efficiency and credit control.
The accounts receivable turnover ratio is not only a measure of a company’s sales efficiency and credit control, but it can also be used to benchmark against industry norms. By comparing your ratio to the average ratio for your industry, you can gain a better understanding of how your business is performing in relation to your competitors. This information can help you identify areas where you may need to improve and set realistic goals for your business.
In this article, we will explain what the accounts receivable turnover ratio is, how to calculate it, and how to use it to improve your business.
What is the Accounts Receivable Turnover Ratio?
The accounts receivable (AR) turnover ratio is a financial metric that measures how quickly a company collects payments from its customers. It is an important indicator of a company’s sales efficiency and credit control. A high ratio indicates that a company is collecting payments quickly, while a low ratio suggests that a company is struggling to collect payments from its customers.
How to Calculate the Accounts Receivable Turnover Ratio
The formula for calculating the accounts receivable turnover ratio is:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
To calculate the net credit sales, you will need to subtract any cash sales from your total sales. The average AR can be calculated by adding the beginning and ending AR for a specific period and dividing by two.
For example, if your net credit sales for the year were $500,000 and your average accounts receivable was $100,000, your accounts receivable turnover ratio would be 5 ($500,000 / $100,000 = 5).
Interpreting the Ratio
A high AR turnover ratio is generally seen as a positive sign, as it indicates that a company is collecting payments quickly. This means that the company has good sales efficiency and credit control. On the other hand, a low ratio can indicate that a company is struggling to collect payments from its customers, which can lead to cash flow problems and potential financial difficulties.
How to Use the Accounts Receivable Turnover Ratio to Improve Your Business
The accounts receivable turnover ratio can provide valuable insights into your business and help you identify areas for improvement. Here are some ways you can use this ratio to improve your business:
Identify Slow-Paying Customers
A low AR turnover ratio can be a sign that you have slow-paying customers. By analyzing your aging report, you can identify which customers are taking the longest to pay their invoices. This information can help you prioritize your collection efforts and implement strategies to encourage these customers to pay on time.
Improve Credit Control
A high AR turnover ratio can indicate that your credit control policies are effective. However, if your ratio is low, it may be a sign that you need to tighten your credit control policies. This could include implementing stricter credit terms, conducting credit checks on new customers, or offering discounts for early payment.
Streamline Your Invoicing Process
A low accounts receivable turnover ratio can also be a sign that your invoicing process is inefficient. If your customers are receiving their invoices late, they may take longer to pay. By streamlining your invoicing process and sending out invoices promptly, you can improve your AR turnover ratio and collect payments more quickly.
Negotiate Better Payment Terms with Suppliers
A high AR turnover ratio can also be beneficial when negotiating payment terms with your suppliers. If you have a good track record of collecting payments quickly, you may be able to negotiate longer payment terms with your suppliers. This can help improve your cash flow and give you more time to pay your bills.
Factors That Can Affect the Accounts Receivable Turnover Ratio
There are several factors that can affect the accounts receivable turnover ratio, including:
The average AR turnover ratio can vary significantly between industries. For example, a retail business may have a higher ratio than a manufacturing company, as retail businesses typically collect payments more quickly.
Seasonal businesses may experience fluctuations in their AR turnover ratio. For example, a business that sells holiday decorations may have a higher ratio during the holiday season and a lower ratio during the rest of the year.
The credit terms you offer to your customers can also affect your AR turnover ratio. If you offer longer payment terms, your ratio may be lower, as it will take longer for you to collect payments from your customers.
The Bottom Line
The accounts receivable turnover ratio is an important financial metric that can provide valuable insights into your business. By understanding this ratio and how to calculate it, you can identify areas for improvement and make informed decisions to improve your sales efficiency and credit control. By regularly monitoring your AR turnover ratio, you can ensure that your business is on track for financial success.
Improve Your Company’s Cash Flow
Whether your company is experiencing rapid growth that’s becoming challenging to manage, or if you’re dealing with delayed client payments, Universal Funding is here to support your expanding business. Reach out to Universal Funding today by calling (800) 405-6035 or by filling out our rate request form to discover how we can enhance your company’s cash flow.