What Is Receivable Turnover Ratio?
Financial ratios are useful tools to analyze and evaluate a company's financial and operational performance. Most of the information used to calculate financial ratios is found on a company's financial statements. The receivables turnover ratio and other ratios can be used to compare a firm against others in its industry, and analyzing several different ratios in combination may help predict future financial troubles.
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Definition
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The ratio of receivables turnover is calculated by dividing a company's annual revenue by its average accounts receivable balance during the same year. Accounts receivables are sales made to customers on credit with terms for customers to pay the balance due, usually within 30 days.
Calculation Example
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Assume that a business had sales of $5,000,000 in one year, and the average balance of its accounts receivable for the same 12-month period was $500,000. The ratio is calculated starting with annual sales and dividing it by the average receivables, which results in a ratio of 10 to 1. This tells the company that, on average, its accounts receivables turned over about every 36 days. The number of days in the year, 365, is divided by the ratio of 10 to arrive at the 36-day turnover rate. The receivables turnover ratio shows the number of times receivables turn over per year, which is different than a closely-related ratio for the average collection period.
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Average Collection Period
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The average collection period ratio provides a business with an average of how many days it takes for receivables to be converted to cash receipts, and is calculated by taking the average accounts receivable and dividing it by the result of the annual amount of sales made on credit, divided by 365 days. The equation can also be calculated as 365 days divided by the receivables turnover. It is important to note that the average collection period result is expressed in terms of a number of days, while the receivables turnover results in a number of "turnover times."
Interpreting the Ratio
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Regardless of the numerical result of the receivables turnover calculation, the same number can mean different things for different companies. Past ratios need to be considered against the current one, and also against standard payment times and turnover ratios for the company's overall industry. Additionally, a business should consider the specific payment terms given to its credit customers.
Concerns
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A receivables turnover ratio is an average result of performance over time, and averages can sometimes hide important outlying pieces of data. For example, some customers may be paying very slowly, which might be offset by others that pay very quickly, and thus hidden in the overall results. The best way to look for this issue is to review the company's accounts receivable aging report to find accounts that do not pay in a timely manner.
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References
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