This ratio is an indication of the efficiency of a company in collecting credit sales. While computing this ratio only credit sale is included. The higher the ratio means greater the efficiency which is a desirable aspect for any company.
In the modern era, financial, managerial and cost accounting have dynamically taken many different roles. The science, mathematics and art of accounting was largely clerical in nature in the beginnings of international trade, that is, in the early 18th century.
However, of recent as commerce has modernized rapidly, the role of accountancy is not just restricted to reporting to management, but has become significantly analytical is nature. Turnover ratios such as the receivables turnover ratio are being used as tools of analysis by the accountants and the financial analysts. The ratio is a tool that measures that status of the accounts receivable turnover.
Please note that though this ratio is about an asset, it is not an asset turnover ratio, but is an activity ratio or a financial ratio and hence has to be treated quite differently than the usual total asset turnover ratios. Here is an explanation of the accounts turnover ratio.
Accounts Receivables Turnover Ratio
The receivables turnover ratio, also known as accounts receivable turnover ratio is basically the ratio between the total sales made with the help of credit and the average amounts that are receivable. The receivables turnover ratio formula goes as follows:
Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Net Credit Sales = total sales with the help of credit, minus all applicable deductions which may also include interest rate as per the company’s policy.
Average Accounts Receivable = Total debts receivable / number of debtors
Receivables Turnover Ratio Example:
Number of debtors = 35
Amount of debt = $315,000
Net Credit Sales = $360,000
Therefore average accounts receivable = Amount of debt / Number of debtors = 315,000 / 35 = 9000
Therefore accounts receivables turnover ratio = Net Credit Sales / Average accounts receivable = 360,000 / 9000 = 40
It must be noted that the net credit sales is not always equal to the total amount of debt owed, it can be more at times and it can also be less.
Receivables Turnover Ratio: Interpretation
The interpretation of the receivables turnover ratio is quite complicated. The output of the formula is principally the number of times that credit accounts are collected, or are to be collected. The interpretation usually depends upon the benchmarks that are set by the general industry. The best turnover ratio for all accounts receivable is connoted to be 50%, or just 50.
However there are several factors that come into such a scenario. There is a rule of thumb that can be followed. A higher ratio indicates that the transactions are being processed on time and that all debtors are paying on time. However, a lower ratio spells an alarm, demanding a change of policy, as it indicates more defaults and non-payments. There is however one very important factor that comes into the picture – cash sales. A large volume of cash sales gives an impolitely large receivables turnover ratio, something which is inevitable. However, in order to prevent such a misleading figure, all cash sales or repaid amounts are deducted from the balance sheet on almost a daily basis. Some firms also add the interest receivable figure to the formula.
The time frame of calculation depends upon the company’s debts and policies. The receivables turnover ratio in some cases is calculated on an hourly basis, while in some cases it is calculated even on yearly basis. Banking and finance companies on the other hand calculate this figure for every account (customer/client) on a daily basis, for better understanding of debt recovery.