What is Accounts Receivable Turnover Ratio?

The Accounts Receivable Turnover Ratio is a financial metric that measures the efficiency of a company in managing and collecting its credit sales or accounts receivable (AR). It helps to evaluate how effectively a company is extending credit to its customers and collecting payments on those outstanding amounts. A higher ratio indicates better efficiency in managing and collecting credit sales, while a lower ratio suggests potential issues with credit policies, collection processes, or customer creditworthiness.

The Accounts Receivable Turnover Ratio is calculated by dividing a company’s net credit sales (total sales minus sales returns, allowances, and discounts) by the average accounts receivable during a specific period. The result is usually expressed as a ratio or a number of times.

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

The average accounts receivable can be calculated by taking the sum of the beginning and ending accounts receivable balances during the period and dividing by two.

A high Accounts Receivable Turnover Ratio implies that the company is collecting payments from its customers quickly and efficiently, which is generally considered favorable as it indicates better cash flow and a reduced risk of bad debts. A low ratio, on the other hand, might indicate that the company has difficulty collecting payments, has a lax credit policy, or faces issues with customer creditworthiness. In such cases, the company may need to review its credit policies, improve its collection processes, or be more selective in extending credit to customers.