Knowing how to figure out the accounts receivable turnover rate is critical for a company to be financially stable. This number helps you determine how well your business gets money from sales on credit. How to calculate accounts receivable turnover ratio from balance sheet will be covered in detail in this piece.
What Is The Accounts Receivable Turnover Ratio?
A financial ratio called the accounts receivable turnover ratio shows how often a business receives its average accounts receivable over a specific period. It shows how well a company’s credit practices work and how well it can collect bills. A company with a high turnover ratio often claims its debts. On the other hand, a low number could mean problems with collecting cash.
Importance Of Accounts Receivable Turnover Ratio
It is essential to understand the accounts receivable turnover ratio for several reasons, including:
Cash Flow Management:
The accounts receivable turnover ratio is an essential part of managing cash flow. It helps businesses plan their cash flow by tracking how well they collect their debts. A high change rate means that the business is good at getting paid. It ensures that money keeps coming in and makes it easier to plan your finances. It also helps you keep up with short-term responsibilities.
Credit Policy Evaluation:
This number is an excellent way to see how well a company’s credit practices work. If the percentage is high, the company has strict credit policies and good ways of collecting debts. On the other hand, a low ratio could mean that loan terms are too easy and that collecting debts isn’t working well. Businesses can change their credit practices to improve collections by looking at this number regularly.
Financial Health Indicator:
The accounts receivable turnover ratio is a crucial indicator of how financially stable a business is. As a result, it shows how well a business handles its debts. It helps show how well it runs and how stable its finances are. Investors and lenders use this number to determine how reliable a company’s cash flow is and how well it can repay its loans.
How To Calculate Accounts Receivable Turnover Ratio
There is a simple method for finding the accounts turnover ratio. However, getting correct financial information is essential to ensure the estimate is accurate. Here’s how to calculate accounts receivable turnover ratio:
Accounts Receivable Turnover Ratio Formula:
To find the ratio, use this simple accounts receivable turnover ratio formula:
- Accounts Receivable Turnover Ratio=Net Credit Sales/Average Accounts Receivable
Net Credit Sales: When you take away returns and allowances from the total credit sales for some time, you get this number.
Average Accounts Receivable: To find this, you usually add up the beginning and finishing accounts receivable for a period. Then, divide them by two.
Step-By-Step Calculation:
Here’s a step-by-step guide on how to calculate accounts receivable turnover ratio from balance sheet:
Determine Net Credit Sales: Get the net credit sales from your income account. Make sure it doesn’t include refunds and sales for cash.
Calculate Average Accounts Receivable:
- Find the accounts receivable at the beginning of the period using the prior balance sheet.
- With the current balance sheet, determine the accounts receivable after the period.
- To determine the average, divide the total accounts receivable at the start and end by two.
Apply the Formula: You get the turnover ratio if you divide the net credit sales by the average accounts outstanding.
Example Calculation:
Assuming Company XYZ has the following year-end financial data:
- $500,000 in net credit sales
- $50,000 in first accounts receivables
- $70,000 in closing Receivables
First, Find the typical outstanding balance:
- Average Accounts Receivable = 50,000 + 70,000 / 2 = 60,000
Next, proceed as directed in the accounts receivable turnover ratio formula:
- Accounts Receivable Turnover Ratio = 500,000 / 60,000 = 8.33
That indicates an 8.33 accounts receivable turnover ratio for Company XYZ. Thus, the business gets its average debt 8.33 times a year.
Accounting Receivable Turnover Ratio Interpretation
Good credit policy and debt collection are strengths of a firm with a high accounts receivable turnover ratio. In such a scenario, strong cash flow and less credit risk can occur.
Conversely, a small accounts receivable turnover ratio might indicate that the business is having difficulties paying off debts. The company could need to enhance its lending procedures, and cash flow problems could surface.
Utilising A Calculator For Accounts Receivable Turnover Ratio
A company may frequently utilise an accounts receivable turnover ratio calculator to make the computation easier. You must put in the net credit sales and the average accounts due for these tools to work. They then figure out the turnover number instantly. Companies that have a lot of data will find this tool very useful. Making sure it’s correct and saving time are both benefits.
Factors Influencing The Turnover Ratio
Several things can affect your accounts receivable turnover ratio, such as:
- Credit Policies: When loan terms are easy, customers may take longer to pay, which can lower the ratio. On the other hand, strict credit rules can raise the percentage by pushing people to pay more quickly.
- Collection Processes: Effective collection methods raise the ratio by ensuring timely payments are made. Follow-ups regularly, automated reminders, and reasonable conflict settlement can all make gathering much more efficient.
- Economic Conditions: When the economy goes down, it can hurt the number. Even if a company has strict credit rules, people with money problems might not pay on time. It might cause the change number to go down.
Raising Your Turnover Ratio For Accounts Receivable
Try these tips to raise your accounts receivable turnover ratio if you perceive it to be low:
- Review Credit Policies: Toughen your credit rules so that you only lend money to people with good credit. It makes the cash flow more stable and lowers the chance of payments being late or not made at all.
- Enhance Collection Efforts: Use robust collection methods to track unpaid bills quickly. To get funds much faster, it’s helpful to remember people and follow up with them regularly.
- Offer Incentives: Customers will pay you sooner if you offer early payment reductions. Early payment discounts might motivate consumers to settle their debts before they expire.
- Regular Monitoring: Always monitor outstanding accounts and follow up on past-due accounts. Regular research helps find accounts that are past due early. It lets you do what you need to do to get back money that is past due.
Also Read: How To Avoid Common Mistakes In Manual Invoicing With Software
Conclusion
You must know how to calculate accounts receivable turnover ratio from balance sheet to maintain sound financial conditions for your company. You can get the correct number using a calculator and following the above procedures. You can also learn more about your credit rules and find ways to make them better. Monitoring and managing your debts regularly will help you keep your cash flow healthy and your finances stable overall.
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FAQs
What does a good accounts receivable turnover ratio look like?
What makes an accounts receivable turnover ratio good varies by business. But generally, a bigger number above 10 means the collection process is working well. It indicates that the firm receives its money back promptly, which enhances cash flow and reduces the possibility of bad debt.
When does the accounts receivable turnover ratio need to be calculated?
Finding the accounts receivable turnover ratio is best done once a year or every three months. Regular monitoring helps find trends and judge how well credit policies are working. It changes things at the right time to improve cash flow and gathering.
When is it ever bad to have a high accounts receivable turnover ratio?
Yes, a very high accounts receivable turnover ratio could mean that credit policies are too strict. Loss of sales is a possibility. To be financially healthy, you must ensure that your credit rules don’t turn off possible customers.
