Accounts Receivable Turnover Ratio

What is accounts receivable turnover ratio?

The accounts receivable turnover ratio is a financial metric that measures how fast a business collects payments from its customers. The ratio shows how often a company’s accounts receivable (the money owed by customers) is collected in a period. The higher the ratio, the quicker the business is collecting its outstanding invoices. A high ratio indicates a company is in good financial shape. The AR turnover ratio helps understand how well a business is converting credit sales into cash.

Key Points

• The Accounts Receivable Turnover Ratio measures how fast you collect payments. It tells you how often a business collects its outstanding invoices in a given period. A higher ratio means faster collections, which is usually a sign of strong cash flow.
• You can calculate the Accounts Receivable Turnover Ratio with a formula. Just divide Net Credit Sales by Average Accounts Receivable. This shows how efficiently your business turns credit sales into cash.
• A “good” Accounts Receivable Turnover Ratio depends on your industry. A high ratio (10+ times per year) usually equates to strong collections but could indicate strict credit policies. A moderate ratio (5-10) is usually healthy, while a low ratio (below 5) might signal slow collections and cash flow issues.

How to calculate accounts receivable turnover ratio

Use the following formula to calculate the accounts receivable turnover ratio:

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

1. Net Credit Sales is the total amount of credit sales your business made in a period (usually a year) minus any returns or allowances.
2. Average Accounts Receivable is the average amount of money owed to you in the same period. To calculate this, add the beginning and ending accounts receivable balances for the period and divide by two.

For example, if your net credit sales for the year were $500,000, and the average accounts receivable for that year was $100,000, your accounts receivable turnover ratio would be:

$500,000 / $100,000 = 5

This means your business collected its outstanding debts 5 times during the year.

What is a good accounts receivable turnover ratio?

Generally, a higher ratio is considered good because you’re collecting debt faster. As a rule of thumb, a ratio of 6 to 12 times a year is typically good for most industries.

A “good” turnover ratio depends on the industry, but in general:

• High Ratio (10+ times per year) – Indicates strong collections and good cash flow, but might mean the company is too strict with credit terms and missing out on sales.
• Moderate Ratio (5-10 times per year) – Typically healthy for most businesses, balancing collections with customer flexibility.
• Low Ratio (Below 5 times per year) – Means slow collections, which could lead to cash flow issues or bad debts.

Remember to compare your business’s ratio to industry standards. Businesses with longer payment terms, like B2B companies or larger corporations, may have lower ratios and still be financially healthy. If your ratio is lower than expected, it could be due to delayed payments or inefficient collections. On the other hand, an extremely high ratio might mean you’re too aggressive with collections and harming customer relationships.

For example, let’s say a furniture store has 90-day payment terms. It might have a lower ratio than a restaurant that gets payments upfront. But as long as the store manages its receivables well and doesn’t have cash flow issues, its lower ratio could still be okay.

The accounts receivable turnover ratio is useful for measuring your business’s credit sales efficiency. By understanding and optimizing this ratio, you can have better cash flow and hopefully avoid any financial problems.