To keep track of the cash flow (movement of money), this has to be recorded in the accounting books (bookkeeping is an integral part of healthy business activity). Net credit sales is the revenue generated when a firm sells its goods or services on credit on a given day - the product is sold, but the money will be paid later. Simple enough, right? As long as you get paid or pay in cash, sure, the act of buying or selling is immediately followed by payment.īut what happens when you pay using a credit card? You still get your product, but the payment is deferred - meaning it is put off to a later time.Īccounting works on a similar mechanism. Want to order that delicious pizza slice? Well, you have to buy it, i.e., pay for it, there and then. Normally whenever you sell something, you get paid immediately. Remember that it’s essential to use the Accounts Receivable Turnover Ratio in conjunction with other financial metrics to get a comprehensive view of a company’s financial health and efficiency.If you want to quickly understand what is the accounts receivables turnover ratio formula, but don't want to get overwhelmed by a brainful of accountings terms, let's go back a little bit and start from the beginning. is efficient in collecting its credit sales from customers, while a lower ratio may suggest issues with the company’s credit policies or collection process. A higher ratio indicates that OfficeFurniture Inc. To assess the company’s efficiency in managing its receivables, you can compare this ratio with industry benchmarks or competitors’ ratios. collected its accounts receivable every (365 days / 9.6) = 38 days. In other words, on average, OfficeFurniture Inc. is 9.6, which means that the company collected its outstanding receivables 9.6 times during the year. The Accounts Receivable Turnover Ratio for OfficeFurniture Inc. Next, calculate the Accounts Receivable Turnover Ratio:Īccounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable Accounts Receivable Turnover Ratio = $1,200,000 / $125,000 = 9.6 Net Credit Sales for the year: $1,200,000 Accounts Receivable at the beginning of the year: $100,000 Accounts Receivable at the end of the year: $150,000įirst, calculate the Average Accounts Receivable:Īverage Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable) / 2 Average Accounts Receivable = ($100,000 + $150,000) / 2 = $125,000 Here is the relevant financial data for OfficeFurniture Inc.: We will use the Accounts Receivable Turnover Ratio to assess the company’s efficiency in collecting its credit sales from customers during a given year. Let’s consider a fictional company called “OfficeFurniture Inc.” that sells office furniture to businesses on credit. Example of the Accounts Receivable Turnover Ratio It’s also important to use the ratio in conjunction with other financial metrics to get a comprehensive view of a company’s financial health and efficiency. Keep in mind that the Accounts Receivable Turnover Ratio does not consider cash sales it focuses solely on credit sales. Comparing the ratio with industry benchmarks or competitor companies can provide a better understanding of a company’s efficiency in managing its receivables. It’s essential to note that the Accounts Receivable Turnover Ratio may vary across industries. A lower ratio may indicate that the company has difficulties collecting payments, slow-paying customers, or issues with its credit policies. Average Accounts Receivable: The average of the opening and closing accounts receivable balances during the same period.Ī higher Accounts Receivable Turnover Ratio indicates that the company is efficient in collecting its credit sales from customers, implying that it has a strong credit policy and collection process in place.Net Credit Sales: Total sales on credit during a specific period, excluding cash sales, returns, and allowances.The formula to calculate the Accounts Receivable Turnover Ratio is:Īccounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable The ratio is also an indicator of a company’s credit and collection policies’ effectiveness. It measures how efficiently a company can convert its accounts receivable into cash during a given period. The Accounts Receivable Turnover Ratio is a financial metric used to evaluate a company’s effectiveness in managing and collecting outstanding credit and receivables from its customers.
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