Introduction

Accounts Receivable (AR) turnover is an essential financial metric for businesses, as it measures their efficiency in managing customer credit and collecting outstanding debts. A higher AR turnover ratio generally indicates that the company is effectively managing its credit policies and collecting payments from customers promptly. In this article, we will discuss the basics of AR turnover and explain how to calculate it.

What is AR Turnover?

AR turnover is a ratio that expresses how many times a company collects its average accounts receivable balance during a given period. It helps businesses assess their effectiveness in managing outstanding revenues, credit policies, and overall cash flow. A low AR turnover may signal that the company’s credit policies are too lenient or that there are excessive delinquencies.

How to Calculate AR Turnover

To calculate the accounts receivable turnover, follow these three steps:

1. Determine net credit sales: Net credit sales are your total sales revenue, excluding cash sales, during the time period being analyzed. Often, net credit sales can be obtained from your accounting records or financial reports. If this information is not readily available, you can estimate net credit sales by subtracting cash sales from total sales.

2. Compute average accounts receivable: To calculate average accounts receivable, add the beginning and ending accounts receivable balances for the time period being analyzed and divide by two. This yields an average balance that accounts for fluctuations throughout the period.

3. Calculate AR Turnover ratio: Divide net credit sales by average accounts receivable to compute the AR turnover ratio.

Formula:

AR Turnover = Net Credit Sales / Average Accounts Receivable

Example

Let’s assume a company has the following financial data:

– Net Credit Sales for the year: $500,000

– Beginning Accounts Receivable: $40,000

– Ending Accounts Receivable: $60,000

Step 1: Determine net credit sales – $500,000 (already given)

Step 2: Compute average accounts receivable:

Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2

= ($40,000 + $60,000) / 2

= $100,000 / 2

= $50,000

Step 3: Calculate AR Turnover ratio:

AR Turnover = Net Credit Sales / Average Accounts Receivable

= $500,000 / $50,000

= 10

In this example, the company’s AR turnover is 10. This indicates that they collected their average accounts receivable balance ten times during the year.

Conclusion

Calculating your business’s accounts receivable turnover is a beneficial way to understand your company’s overall credit management and cash flow efficiency. By using the simple steps and formula outlined above, you can evaluate your performance and identify potential areas for improvement. A higher AR turnover is generally preferable; however, it’s crucial to consider industry norms when evaluating your business.