Receivable turnover definition
/What is Receivable Turnover?
Receivable turnover is a measure of how quickly a company is collecting its sales that were made on credit. This refers to sales for which cash payment was delayed until after the sale date. A high rate of turnover occurs when the proportion of receivables to sales is low.
When to Measure Receivable Turnover
Here are five situations where monitoring the receivable turnover metric makes sense:
Evaluating credit policies. When a company extends credit to customers, tracking receivable turnover helps assess if the credit terms are too lenient or too strict. A low turnover rate may indicate that customers are taking too long to pay, suggesting a need to tighten credit policies or improve collection efforts.
Managing cash flow. For businesses with tight cash flow, like retail or manufacturing, monitoring receivable turnover is vital. A high turnover rate ensures a steady inflow of cash, helping the company meet its operational expenses and investment needs without resorting to borrowing.
Assessing customer quality. If a company has a mix of customers, analyzing receivable turnover can reveal which customer segments are slow to pay. This information helps prioritize collections efforts or reconsider relationships with high-risk customers.
Planning for expansion or investment. Before securing loans or attracting investors, a company needs to demonstrate financial health and efficiency. A strong receivable turnover ratio signals that the business effectively manages its receivables, making it more attractive to lenders and investors.
Detecting financial distress. A sudden decline in receivable turnover can be an early warning sign of financial trouble, such as deteriorating customer payment habits or weakening sales. Regular tracking allows management to identify and address these issues promptly, preventing further cash flow problems.
Factors Impacting Receivable Turnover
There are several factors impacting receivable turnover, all of which are critical to understanding how receivables can be collected more quickly, thereby reducing your investment in working capital. These factors are as follows:
Credit policy setting. If a company offers credit to essentially all customers (known as a loose credit policy), then some customers will delay their payments or never pay at all. Conversely, a tight credit policy accelerates receivable turnover, since customers are allowed less credit.
Collection persistence. A company that persistently contacts its customers for payment will reduce the amount of receivable turnover, on the assumption that these contacts result in more cash receipts.
Invoicing errors. If invoices to customers contain errors or are sent to the wrong address or person, then payment will be delayed.
Industry practice. If customers within a certain industry are accustomed to delayed payments, this attitude may persist even for those companies attempting to accelerate payment.
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How to Calculate Receivable Turnover
The calculation of receivable turnover is to divide net credit sales for the year by the average amount of accounts receivable outstanding during that period. Average accounts receivable is usually calculated as the sum of the beginning and ending accounts receivable, divided by two. Thus, the receivable turnover formula is:
Net annual credit sales ÷ ((beginning receivables + ending receivables) ÷ 2) = Receivable turnover
A high turnover figure indicates that a business has the ability to collect accounts receivable from its customers very quickly, while a low turnover figure indicates the reverse. You should track the receivable turnover metric on a trend line in order to see gradual changes in turnover performance that might not be so obvious if you were to only calculate it occasionally.
If you want to convert the receivable turnover figure into days of accounts receivable outstanding, just divide the turnover amount into 365 days. Thus, a turnover of 8.0 equates to 45.6 days of accounts receivable outstanding (calculated as 365 days / 8.0 turnover).
Aged Accounts Receivable Report
Do not rely solely upon the receivable turnover calculation to evaluate the ability of a company to collect its accounts receivable, since this metric is only an average of the individual accounts receivable. You should also investigate the aged accounts receivable report to gain a clear understanding of the status of a company's collections. A typical aging report lists invoices in 30-day “buckets,” where the columns contain the following information:
The left-most column contains all invoices that are 30 days old or less
The next column contains invoices that are 31-60 days old
The next column contains invoices that are 61-90 days old
The final column contains all older invoices
The report is sorted by customer name, with all invoices for each customer itemized directly below the customer name, usually sorted by either invoice number or invoice date. A sample report appears in the following exhibit, though without the individual invoice detail that is usually found in such a report.
Example of Receivable Turnover
ABC International had $2,880,000 of net credit sales in its most recent 12-month period, and the average accounts receivable during that period was $480,000. The receivable turnover is 6.0 (calculated as $2,880,000 annual net credit sales divided by $480,000 average accounts receivable). This turnover translates into 60.8 days of accounts receivable outstanding (calculated as 365 days / 6.0 turns).
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