In order to keep an eye on how the credit and collections team is doing. This can determine whether a business needs to tighten or loosen their restrictions on offering credit to customers, and can make or break their cash flow. One often used calculation is the accounts receivable turnover ratio.

The accounts receivable turnover ratio shows how many time per year a business was able to collect on its average accounts receivable.The higher the accounts receivable turnover ratio number, the more often the business is collecting on outstanding accounts. A high turnover ratio is an indication that the collection department is working aggressively and customers are paying their accounts on time. A low turnover ratio is an indication that the business is struggling to collect and have customers that aren’t doing well financially. It can also be an indication that the business is not doing well financially, either.

The formula for accounts receivable turnover ratio begins by adding together the beginning and ending accounts receivable for the measurement period, then divide by the net annual credit sales.

Net Annual Credit Sales
(Beginning Accounts Receivable + Ending Accounts Receivable)/2

For example, if your company’s beginning accounts receivable for the period was $525,000 and the ending balance was $560,000, you would add those two figures together and divide by two. If your company’s net credit sales equaled $5,300,000, you would then divide that by the previous number you calculated.

$5,300,000 Net Credit Sales
($525,000 Beginning Receivables + $560,000 Ending Receivables)/2
$5,300,000 Net Credit Sales
$542,500 Average Accounts Receivable

9.7 Accounts Receivable Turnover Ratio

By tracking the accounts receivable turnover ratio, you are able to see improvement over time. If you see the ratio decreasing, it allows you to take action and prevent the problem from worsening by implementing new accounts receivable strategies and tools.

Every business uses different calculations to determine how well they are doing in their accounts receivable department. Depending on what company you are talking to, they may use day’s sales outstanding, a collections ratio or an accounts receivable turnover ratio. All of these are important to calculate, however, they can all come with their flaws, so it is important to use multiple calculations to determine exactly how well your accounts receivable department is doing.