Accounts Receivable Turnover Ratio

Accounts Receivable Turnover Ratio is a type of Turnover Ratio that determines the efficiency with which a business is using its assets. In other words, this ration tells how good a company is in collecting the receivable or money owed to it. Accounts Receivable Turnover Ratio is also known as Trade Receivable Turnover Ratio or Debtor’s Turnover Ratio.
Where,
Net Credit Sales = Total Sales During the Period (Excluding Sales Returns, Sales Allowances, and Sales for which payment is received in Cash)

Significance and Interpretation

Accounts Receivable Turnover Ratio tells the number of times the receivables are turned over and converted into cash over a period.
  • High Accounts Receivable Turnover Ratio indicates the efficiency of a company is receiving its debts over a period, it is desirable to have a high value of this ratio.
  • However, it should be noted that a High Accounts Receivable Turnover Ratio may also imply that a company may be following a Conservative Credit Policy i.e. it is giving credit strictly to Credit Worthy customers.
  • Low Accounts Receivable Turnover Ratio indicates that the company is not able to collect its Receivables properly or the company is not following a good credit policy. Low values of this ratio are not desirable/healthy for a company.
  • It must be noted that while comparing two companies on the grounds of Accounts Receivable Turnover Ratio, they should be of the same industry.

Examples

Example 1: 

Use the following data of ABC Ltd, to calculate its Accounts Receivable Turnover Ratio.
  • Total Sales during FY = Rs. 2000000.00
  • Sales return during FY = 10% of Total Sales
  • Sales in Cash = 25% of Total Sales
  • Accounts receivable at the Beginning of FY = Rs 250000.00
  • Accounts receivable at the End of FY = Rs 350000.00 

Solution:

Net Credit Sales = Total Sales – Sales Returns – Sales in Cash
(2000000 – 200000– 500000)
Net Credit Sales = Rs. 1300000.00

Average Accounts Receivable = (250000 + 250000) / 2
⇨  Rs. 300000.00
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
⇨  1300000 / 300000 = 4.33
Hence, Accounts Receivable Turnover Ratio = 4.33
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