Accounts Receivable Turnover Ratio

What is the Accounts Receivable Turnover Ratio?

The Accounts Receivable Turnover Ratio measures how efficiently a company collects payments from its customers over a specific period. It shows how many times, on average, a business converts its credit sales into cash, helping assess the effectiveness of its credit and collection policies.

Key Takeaways

• Measures how efficiently a company collects customer payments.
• A higher ratio indicates fast and efficient collections.
• A lower ratio suggests slow payments or lenient credit policies.
• Helps assess liquidity, credit risk, and cash flow management.
• Often paired with the Days Sales Outstanding (DSO) metric.

Understanding the Accounts Receivable Turnover Ratio

The Accounts Receivable Turnover Ratio indicates how many times per year a company’s receivables are collected and renewed. It reflects how effective the company is at turning credit sales into cash. A high turnover ratio means customers pay their debts quickly, improving liquidity and reducing bad debt risk. A low ratio may indicate inefficient collection efforts or credit policies that are too generous.

Credit-intensive industries such as manufacturing, wholesale, and real estate often have lower ratios compared to cash-based industries like retail.

This ratio is vital for working capital management, helping businesses balance credit sales growth with sustainable cash flow.

Formula (If Applicable)

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

To convert this ratio into the average collection period (in days):
Days Sales Outstanding (DSO) = 365 / Accounts Receivable Turnover Ratio

A lower DSO indicates faster collection and better liquidity.

Real-World Example

A company reports:

• Net Credit Sales: $1,200,000
• Beginning Accounts Receivable: $150,000
• Ending Accounts Receivable: $210,000

Average Accounts Receivable = ($150,000 + $210,000) / 2 = $180,000
Accounts Receivable Turnover Ratio = $1,200,000 / $180,000 = 6.67 times

This means the company collects its average receivables approximately 6.7 times per year, or every 55 days (365 ÷ 6.67).

Importance in Business or Economics

The Accounts Receivable Turnover Ratio provides insight into a company’s cash flow efficiency and credit management. It helps stakeholders:

• Evaluate how quickly cash is collected to fund operations.
• Identify potential credit risks or late-paying customers.
• Optimize credit policies to balance growth and liquidity.

Economically, widespread shifts in receivable turnover across industries can indicate changes in credit conditions, lending standards, or consumer confidence.

Types or Variations

• Annual Receivable Turnover Ratio: Standard metric for annual reporting.
• Quarterly Turnover Ratio: Used for short-term performance tracking.
• Days Sales Outstanding (DSO): Converts ratio into days for easier interpretation.
• Adjusted Ratio: Excludes doubtful accounts for a more conservative measure.

Related Terms

• Accounts Payable Turnover Ratio
• Working Capital Management
• Days Sales Outstanding (DSO)
• Liquidity Ratios
• Credit Risk Analysis

Sources and Further Reading

• Financial Accounting Standards Board (FASB): https://www.fasb.org
• Investopedia – Accounts Receivable Turnover Ratio: https://www.investopedia.com/terms/a/accountsreceivableturnoverratio.asp
• Corporate Finance Institute (CFI): https://corporatefinanceinstitute.com

Quick Reference

• Purpose: Measure efficiency of credit and collections.
• Formula: Net Credit Sales ÷ Average Accounts Receivable.
• High Ratio: Faster collections, stronger liquidity.
• Low Ratio: Slow collections, possible cash flow strain.
• Paired Metric: Days Sales Outstanding (DSO).

Frequently Asked Questions (FAQs)

What does a high Accounts Receivable Turnover Ratio indicate?
It indicates efficient collection processes and disciplined credit management.

Is a low ratio always bad?
Not always — it could reflect lenient credit terms designed to increase sales.

How does this ratio relate to DSO?
They are inversely related — a high turnover ratio means a low average collection period.

Why is this ratio important for investors?
It reveals how effectively a company converts its sales into actual cash, impacting liquidity and profitability.

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