In the UK, 2 out of 5 small-to-medium businesses (SMBs) experience serious cash flow problems as a result of late payments, while recent reports estimate the cost of late payments to SMEs to be at least £51.5 billion per year. Put simply, chasing late payers has become the norm in many industries across the UK. Optimising your accounts receivable process is one of the best ways to deal with late payments. But to gain insight into the efficacy of your accounts receivable processes, you’ll need to know your accounts receivable turnover ratio. Find out more about the AR turnover ratio, right here.
What is the AR turnover ratio?
The accounts receivable turnover ratio, which is also known as the debtor’s turnover ratio, is a simple calculation that is used to measure how effective your company is at collecting accounts receivable (money owed by clients). Typically measured on an annual basis, a high receivables turnover ratio may mean that your company’s accounts receivable process is effective, and that you have large numbers of high-quality clients who are happy to pay their debt quickly.
However, a high AR turnover ratio could also indicate that your company is very conservative when it comes to offering credit. That’s not necessarily a bad thing, but it’s worth remembering that it could drive potential customers into the arms of competing companies that are willing to offer credit. By contrast, a low receivables turnover ratio could be caused by the fact that your company has bad credit policies, a poor collection process, or deals too often with customers that aren’t creditworthy.
If your company does have a low AR turnover ratio, optimising accounts receivable could be a good move. Take a look at our article on accounts receivable process improvement ideas for inspiration.
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How to find accounts receivable turnover
If you’re trying to work out how to find accounts receivable turnover, there’s a simple receivables turnover ratio formula you can use:
Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Once you know the formula, you just need to follow these steps to calculate your AR turnover ratio:
Determine your net credit sales – Your net credit sales are all the sales that you made throughout the year that were made on credit. If you’re struggling, you should be able to find your net credit sales on your balance sheet.
Work out your average accounts receivable – Next up, you need to take the total number of accounts receivable entries at the beginning of the year, add it to the value of your accounts receivable at the end of the year, and then divide by two. This will give you a figure for average accounts receivable.
Find your accounts receivable turnover – Finally, you just need to divide your net credit sales by your average accounts receivable, and you should end up with your receivables turnover ratio.
You can also use an accounts receivable turnover ratio calculator – such as this one – to work out your AR turnover ratio. Assuming you know your net credit sales and average accounts receivable, all you need to do is plug them into the accounts receivable turnover ratio calculator, and you’re good to go.
AR turnover ratio example
To give you a little more clarity, let’s look at an example of how you could use the receivables turnover ratio in the real world. Company A has £150,000 in net credit sales for the year, along with an average accounts receivable of £50,000. To determine the AR turnover ratio, you simply divide £150,000 by £50,000, resulting in a score of 3. This means that Company A is collecting their accounts receivable three times per year. That’s not bad, but it may indicate that Company A should attempt to optimise their accounts receivable to speed up the collections process.
Are there any limitations to the accounts receivable turnover ratio?
While the AR turnover ratio can be extremely helpful, it’s not without drawbacks. First off, the ratio is an effective way to spot trends, but it can’t help you to identify bad customer accounts that need to be reviewed. In addition, the ratio can be skewed by particularly fast or slow-paying customers, giving a less than accurate picture of your overall collections process.
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