- Introduction
- Definition of turnover ratio?
- What is accounts receivables turnover ratio
- Accounts Receivable Turnover Ratio Formula
- Components of accounts receivables turnover ratio
- Steps to calculate accounts receivables turnover ratio
- Accounts receivables turnover ratio example
- Interpretation of Accounts Receivable Turnover Ratio
- What are higher or lower accounts receivable turnover?
- Limitations of the Accounts Receivables Turnover Ratio
- Frequently asked questions
Introduction
Accounts Receivable Turnover Ratio (ARTR) is the financial ratio that gauges how quickly a business gets money from its customers. This gives a clear indication of how often a company can convert its credit sales into cash within a specified period.
Managing receivables is crucial for any business to maintain liquidity and smooth operation. A company that extends payment will have cash flow issues and cannot pay suppliers, employees, and other obligations on time. A high receivables turnover ratio means the company has a sound collection system, which reduces the risk of bad debts and makes the company financially stable.
This ratio helps business owners, investors, and financial analysts to assess a company’s credit management policies and economic health. A high accounts receivable turnover ratio is a good sign for any company because it helps maintain healthy cash flows and reduce outstanding debts.
What is accounts receivables turnover ratio?
Accounts Receivables Turnover ratio is also known as debtors turnover ratio. This indicates the number of times average debtors have been converted into cash during a year. This is also referred to as the efficiency ratio that measures the company's ability to collect revenue. It also helps interpret the efficiency in using a company's assets in the most optimum way.
Accounts receivable turnover ratio formula
The receivables turnover ratio is determined by dividing the net credit sales by average debtors.
Debtor Turnover Ratio = Net Credit Sales / Average Trade Debtors
Components of accounts receivables turnover ratio
Net credit sales
The aggregate amount of sales or services rendered by an enterprise to its customers on credit. The terms gross credit sales and net credit sales are sometimes used to distinguish the sales aggregate before and after deduction of returns and trade discounts. The concept of net credit sales is an indicator of the total amount of credit that a company is granting to its customers.
Average trade debtors
A trade debtor is a person from whom amounts are due for goods sold or services rendered or in respect of contractual obligations. Also termed as a debtor, bills receivables or account receivable.
Trade debtor includes sundry debtors and bill’s receivables and the formula to determine average trade debtors is given below:
Average trade debtors ( Opening + Closing balances / 2 )
Note: When any information about credit sales, opening and closing balances of trade debtors is not available then the ratio can be calculated by dividing total sales by closing balances of trade debtor
Debtor Turnover Ratio = Total Sales / Trade Debtors
Steps to calculate accounts receivables turnover ratio
Step 1: Determine your net credit sales
The first part of the accounts receivable turnover formula calls for net credit sales, or in other words, all of the sales for the year that were made on credit (as opposed to cash). This figure should include the total credit sales, minus any returns or allowances. We should be able to find the net credit sales number in the annual income statement or Profit & Loss a/c.
Step 2: Determine your average accounts receivable
Once we have the net credit sales figure, the second part of the accounts receivable turnover formula requires the average accounts receivable.
Accounts receivable refers to the money that’s owed to a business by its customers. In order to find the average accounts receivable, we will have to take the number of your accounts receivable at the beginning of the year, add it with the value of your accounts receivable at the end of the year, and divide by two to find the average. We should be able to find the necessary accounts receivable numbers on the balance sheet.
Step 3: Apply the accounts receivable formula
Once we have these two values, we will be able to use the accounts receivable turnover formula. And then we will divide the net credit sales by the average accounts receivable to calculate the accounts receivable turnover ratio, or rate.
Accounts receivables turnover ratio example
Let’s say MAX Ltd., made 100,000 Indo rupiah in net credit sales for the year and had sales returns amounting to 20,000 Indo rupiah, with average accounts receivable of 25,000 Indo rupiah. What is the Receivables Turnover ratio of MAX Ltd?
Step 1 : Net Credit Sales = Sales ( - ) Sales returns
In the given example it works out to 80,000 Indo rupiah
Step 2: Average accounts receivable (already given in the example as 25000 Indo rupiah )
Step 3 : Divide = Net credit sales/ Average accounts receivable
In the given example, 80,000/25,000 = 3.2 (Accounts Receivables Turnover ratio)
Interpreting the accounts receivable turnover ratio
The ARTR provides insights into a company's efficiency in collecting outstanding invoices.
High ratio (Good sign)
- Indicates effective credit management and efficient collection policies.
- Suggests that customers pay their invoices quickly, improving cash flow.
- Reduces the risk of bad debts.
Low ratio (Warning sign)
- Suggests inefficiencies in the company’s receivables collection process.
- Indicates lenient credit policies or customers facing financial difficulties.
- Results in cash flow problems, affecting operational efficiency.
Industry benchmarks for accounts receivable turnover ratio
Each sector has different standard Accounts Receivable Turnover Ratio (ARTR) values. A good ARTR varies depending on the industry. Comparing your business ratio with industry benchmarks can help assess collection efficiency.
Some industry-specific benchmarks have been listed below:
A company should strive to align with or exceed its industry benchmark to ensure smooth financial operations.
Accounts receivable management with Tally ERP
Tally ERP is an accounting software solution that helps businesses streamline their accounts receivable processes and improve their turnover ratio.
The features that make Tally optimise a business’ ARTR are as follows:
- Automated invoicing & payment reminders: It generates invoices and sends timely payment reminders to customers.
- Efficient credit management: It tracks outstanding receivables and helps set clear credit policies.
- Customisable reports: They provide insights into collections, overdue payments, and financial performance.
- Alerts & notifications: These allow businesses to proactively follow up on unpaid invoices.
Companies can significantly reduce collection delays and improve their cash flow using Tally ERP.
Impact of accounts receivable turnover ratio on cash flow
A business' cash flow is directly influenced by its accounts receivable turnover ratio.
High ARTR equals positive cash flow
- Faster collections lead to better liquidity.
- Ensures availability of funds for business operations.
Low ARTR equals cash flow issues
- Slow collections create working capital shortages.
- Leads to payment delays to suppliers and employees.
How to improve the accounts receivable turnover ratio
The ARTR can be improved by implementing the following ways:
- Offer discounts for early payments – This encourages faster payments.
- Use automated billing systems – It ensures timely invoicing and reminders.
- Implement clear credit policies– This helps set payment terms to avoid bad debts.
- Regularly monitor receivables – It helps identify and address collection issues.
Conclusion
The accounts receivable turnover ratio is a key metric for assessing a company's efficiency in collecting payments. A higher ratio indicates stronger credit management, while a lower ratio may signal collection inefficiencies.
By using Tally ERP and adopting best practices like automated invoicing, better credit policies, and regular monitoring, businesses can optimise their accounts receivable processes and enhance cash flow.
Frequently asked questions
1. What is the accounts receivable turnover ratio?
The Accounts Receivable Turnover Ratio (ARTR) is a financial metric that evaluates how efficiently a company collects outstanding credit sales from its customers. It measures the number of times a business converts its accounts receivable into cash over a specific period.
A higher ARTR indicates strong collection efficiency, while a lower ARTR may suggest payment delays or weak credit management.
2. How do you calculate the accounts receivable turnover ratio?
To calculate the ARTR, use the following formula:
- ARTR= Net credit sales / Average accounts receivable
- Net credit sales: Total revenue from credit transactions (excluding cash sales and returns).
Average accounts receivable: (Beginning accounts receivable + Ending accounts receivable) ÷ 2.
3. What does a high accounts receivable turnover ratio indicate?
A high ARTR indicates:
- Customers settle their invoices at the scheduled payment date.
- The company implements effective policies for credit management and collections.
- The business operates with a solid cash flow system that maintains its liquidity.
High ARTR levels also suggest the organisation might hold too many restrictive credit standards that deter customers from buying on credit.
4. What is considered a good accounts receivable turnover ratio?
A good ARTR depends on the industry and business model. For instance:
- Retail & consumer goods: 10–15 (due to fast-moving transactions).
- Manufacturing: 5–10 (depends on bulk orders and extended payment terms).
- Service industry: 3–8 (payments may be delayed due to service agreements).
A low ratio in a high-turnover industry (e.g., retail) may indicate slow collections. In contrast, a high ratio in a slow-turnover sector (e.g., real estate) may suggest aggressive collection strategies.
5. How does the accounts receivable turnover ratio affect cash flow?
A higher ARTR improves cash flow, while a lower value may cause liquidity issues. By monitoring and improving this ratio, businesses can maintain financial stability and operational efficiency.
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