What Is the Receivables Turnover Ratio? (Plus Examples)

By Indeed Editorial Team

Published 7 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

The ability to collect payments on time is an important metric to track for businesses. There are a number of ways to track this metric, including the receivables turnover ratio. Learning about this ratio may help you understand how your team's ability to collect payments on time compares to others in the market and industry. In this article, we discuss what this ratio is, describe why you may use it, explore how to calculate it and discover what it can tell you.

What is the receivables turnover ratio?

The receivables turnover ratio measures a business's ability to collect payments its customers owe for products or services. If the company allows customers to make purchases on credit, this ratio is an effective metric for evaluating how efficiently the company collects extended credit and short-term payments. This accounting metric is also an important indicator of how effectively companies manage customer credit accounts, as the ratio provides insight into whether companies extend too much credit. To find receivables turnover, apply the formula:

Receivables turnover ratio = net sales on credit / average receivables

In the formula, the net credit sales value represents the total amount of credit sales the company makes over a specific period. The average receivables value is the average amount the receivables account collects in the same period. Dividing these two values provides you with this ratio.

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Why use this ratio?

There are many reasons to use this ratio. Here are some of them:

  • Evaluates a company's ability to collect payments: This ratio tells you if credit sales are greater than the average amount the company collects in receivables over a specific period. This number can give you some insight into how well the company is managing customer credit accounts.

  • Helps measure credit policy: This ratio indicates whether a business is extending too much or too little credit, and thus can be a useful indicator of credit policy.

  • Shows whether a company is focusing on profitability or growth: A low ratio, particularly one that has a downward trend, might mean that the company's focus isn't solely on producing profit but also on meeting sales and growing the business over time.

  • Measures efficiency of cash conversion: This ratio can measure the flow of cash in a business, as it helps you see how efficiently the company collects on receivables to convert them into cash.

  • Helps identify developing trends: This ratio can be an effective tool for helping you identify trends in customer payments, such as a decrease in overdue accounts.

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What does this ratio tell you?

The specific value you receive for this ratio can provide valuable information about your team's ability to collect payments on time. A value closer to 1.00 or 100% shows that they collect almost all the payments on time, whereas a value closer to 0.00 indicates that nearly no payment collections occur on time. As an example, if a team has a turnover ratio of 0.59, that means they collect 59% of the payments on time.

How to calculate this ratio

Use the ratio formula and the following steps to calculate this ratio:

1. Calculate the average accounts receivable

Determine what the average value of the company's accounts receivable is for the period you're measuring. Locate the balance for the beginning of the current period and the balance for the end of the period you measure. Add these two values together and divide the sum by two to get the average. You can calculate the average receivables with this formula:

Average accounts receivable = (starting balance + ending balance) / 2

2. Find the total amount in credit sales

To determine how much revenue the company earns from all its credit sales, subtract the total value in returns from all sales on credit. Then, subtract the sales allowances from this difference. The result is the net credit sales. This formula is an effective tool for finding this value quickly:

Net sales on credit = (all credit sales - total returns) - sales allowances

3. Divide the credit sales by the receivables

Once you have both your average accounts receivables and the net sales on credit values, you can do the division. Using this ratio formula, divide the credit sales by the average receivables. The result is the turnover ratio, which can provide the insight you can use to evaluate the efficiency of revenue conversion to income.

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Tips for improving this ratio

Here are some tips you can follow that may help you improve your team's ratio:

Enact stringent credit policies

Companies may follow certain procedures when they consider extending credit and collecting payments. By following these guidelines, your team may have a better chance of collecting payments quickly and efficiently, which improves your ability to meet financial goals such as operating profit margin and cash conversion cycle. Your team can train employees in these policies and procedures so that everyone knows how to handle any issues as they arise.

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Train a credit and collections team

If the company doesn't have a credit and collections team, consider training employees to perform these tasks so that you can collect all the receivables on time, which improves your ability to meet financial goals. The team may review accounts receivable at the end of each month and determine which are past due. They can then call or send letters to the customers requesting payment if they don't receive an initial payment when it's due.

Implement late payment tracking and penalties

To improve your team's cash flow, it's important to track payments that are past due. Consider setting up a system for employees to enter accounts that have non-payments so that the company can accurately track outstanding receivables over a period. Your team can also create policies on how to enforce penalties and fees when customers don't pay on time.

Track customer performance and sales trends

Your team can track customer credit information, such as account numbers and balances, to identify trends in payment collection. If sales are increasing for your products or services, but you fail to collect payments on time, this could indicate that customers are less likely to pay in the future. To prevent this from occurring, the company may consider changing credit policies to ensure it treats all customers fairly.

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Examples of calculating this ratio

These are some examples of calculating this ratio:

Calculating net sales on credit

Assuming a marketing firm extends client credit based on 30-day collection periods, financial analysts want to understand how effectively the company's receivables collect on customer payments. Before the analysts can calculate the receivables turnover, they calculate the net sales on credit using the formula:

Net sales on credit = (all credit sales - total returns) - sales allowances

Example: At the end of the quarter, the company's totals in credit sales, credit returns and sales allowances are $445,000, $108,000 and $68,000 respectively. The analysts find:

Net sales on credit = (all credit sales - total returns) - sales allowances

= ($445,000 - $108,000) - $68,000

= $337,000 - $68,000

= $269,000

Calculating average accounts receivable

Using the same example, the analysts then determine the average accounts receivable using the formula:

Average accounts receivable = (starting balance + ending balance) / 2

Example: Assuming the company's starting receivables balance is $410,000 and the ending balance is $385,000, the analysts calculate the average with the equation:

Average accounts receivable = ($410,000 + $385,000) / 2

= ($795,000) / 2

= $397,500

Calculating the receivables turnover ratio

After calculating both the net credit sales and the average accounts receivables, the analysts can use these values to determine the turnover ratio for their company's receivables. Using the formula:

Ratio = net sales on credit / average receivables

Example:

$269,000 / $397,500 = 0.68

= 68%

This value shows the company's receivables turnover ratio is 68%. So for all sales on credit the company makes, 68% of client payments arrive on time. This can show a need for improvement or additional evaluation of clients before extending credit. In contrast, this ratio may show a healthy turnover rate, depending on what the industry average is for similar marketing services.

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