Definition
Accounts Receivable Turnover is a financial ratio that measures the number of times a company collects its average accounts receivable balance in a particular period, typically a year. It is calculated by dividing total credit sales by the average accounts receivable during that period. This ratio provides insight into the efficiency of the company’s credit and collection policies.
\[ \text{Accounts Receivable Turnover} = \frac{\text{Total Credit Sales}}{\text{Average Accounts Receivable}} \]
Examples
-
Example 1:
- Total Credit Sales: $500,000
- Beginning Accounts Receivable: $50,000
- Ending Accounts Receivable: $70,000
- Average Accounts Receivable: \(\frac{50,000 + 70,000}{2} = 60,000\)
\[
\text{Accounts Receivable Turnover} = \frac{500,000}{60,000} \approx 8.33
\]
-
Example 2:
- Total Credit Sales: $1,000,000
- Beginning Accounts Receivable: $150,000
- Ending Accounts Receivable: $100,000
- Average Accounts Receivable: \(\frac{150,000 + 100,000}{2} = 125,000\)
\[
\text{Accounts Receivable Turnover} = \frac{1,000,000}{125,000} = 8
\]
Frequently Asked Questions
Q: What does a higher Accounts Receivable Turnover ratio indicate?
A higher ratio suggests that the company is efficient at collecting its receivables, indicating healthy cash flow and effective credit policies.
Q: What are the potential downsides of a very high Accounts Receivable Turnover ratio?
If the turnover ratio is too high, it might indicate that the company’s credit policy is too strict and could be missing out on sales opportunities.
Q: How often should a company review its Accounts Receivable Turnover ratio?
Ideally, this ratio should be reviewed quarterly and annually to maintain optimal cash flow and credit management.
Q: Can Accounts Receivable Turnover vary by industry?
Yes, industry norms can affect this ratio, with some industries naturally having longer collection periods and others having shorter ones.
- Accounts Receivable (AR): Money owed by customers to a company for goods or services sold on credit.
- Collection Ratio: Measures the efficiency of a company’s ability to collect on its accounts receivables.
- Credit Sales: Sales where payment is delayed beyond the point of sale.
- Average Accounts Receivable: The average amount of receivables during a specific period, often calculated as the sum of beginning and ending receivables divided by two.
Online References
- Investopedia - Accounts Receivable Turnover Ratio
- AccountingCoach - Accounts Receivable Turnover
- Corporate Finance Institute - AR Turnover Ratio
Suggested Books for Further Studies
- “Financial Intelligence for Entrepreneurs: What You Really Need to Know About the Numbers” by Karen Berman and Joe Knight
- “Accounting for Non-Accountants: The Fast and Easy Way to Learn the Basics” by Wayne Label
- “Financial Statement Analysis and Security Valuation” by Stephen Penman
Fundamentals of Accounts Receivable Turnover: Accounting Basics Quiz
### What does the Accounts Receivable Turnover ratio measure?
- [ ] The amount of cash in the bank.
- [x] The number of times a company collects its average accounts receivable.
- [ ] The profit margin of sales.
- [ ] The valuation of inventory.
> **Explanation:** The Accounts Receivable Turnover ratio measures how many times a company collects its average accounts receivable during a specified period, indicating its efficiency in managing credit sales.
### What is the term for the sum total calculated as the average of the beginning and ending accounts receivables?
- [ ] Net Receivables
- [x] Average Accounts Receivable
- [ ] Gross Receivables
- [ ] Accrued Receivables
> **Explanation:** The Average Accounts Receivable is the calculated sum total of the beginning and ending accounts receivables, divided by two.
### Which of the following can signify a too high Accounts Receivable Turnover ratio?
- [ ] Healthy growth in sales.
- [ ] Effective marketing strategies.
- [x] Too strict credit policies.
- [ ] None of the above.
> **Explanation:** A very high turnover ratio might indicate overly stringent credit policies which could hinder potential sales.
### What could a consistently low Accounts Receivable Turnover ratio indicate about a company's receivable management?
- [x] Inefficiency in collection.
- [ ] Overly strict credit policies.
- [ ] Healthy cash flow.
- [ ] Increase in net income.
> **Explanation:** A consistently low accounts receivable turnover ratio could indicate inefficiency in collecting receivables, leading to potential liquidity problems.
### In what way can the industry affect the Accounts Receivable Turnover ratio?
- [x] Different industries have varied norms for collection periods.
- [ ] Industries have no effect on the ratio.
- [ ] Accounts receivable is unaffected by industry types.
- [ ] Only the size of the company matters.
> **Explanation:** Industry norms vary, with some industries naturally having longer collection periods compared to others, impacting the Accounts Receivable Turnover ratio.
### How do you calculate the Average Accounts Receivable?
- [ ] Sum of net sales over periods.
- [ ] Beginning balance of the period.
- [x] Sum of beginning and ending balances divided by two.
- [ ] Ending balance of the period.
> **Explanation:** The Average Accounts Receivable is calculated as the sum of the beginning and ending balances of accounts receivables divided by two.
### Would a company's income statement directly show the Accounts Receivable Turnover ratio?
- [ ] Yes, it is always listed.
- [ ] Sometimes, depending on the company.
- [x] No, it is calculated from financial data.
- [ ] It is shown if there are receivables.
> **Explanation:** The Accounts Receivable Turnover ratio is not directly shown on the income statement; it is calculated using data from the company's financial statements.
### Can Total Cash Sales be used to calculate the Accounts Receivable Turnover ratio?
- [x] No, only Total Credit Sales are used.
- [ ] Yes, because all sales are included.
- [ ] It can include both credit and cash sales.
- [ ] Neither can be used.
> **Explanation:** Only Total Credit Sales are used in the calculation of the Accounts Receivable Turnover ratio, as cash sales are immediately collected.
### Which accounting metric provides insight into the efficiency of a company’s credit and collection policies?
- [x] Accounts Receivable Turnover
- [ ] Gross Profit Ratio
- [ ] Debt-to-Equity Ratio
- [ ] Earnings Per Share
> **Explanation:** The Accounts Receivable Turnover ratio provides insight into how effectively a company manages and collects its credit sales, indicating the efficiency of its credit and collection policies.
### What financial action can be directly influenced by improvements in the Accounts Receivable Turnover ratio?
- [ ] Increasing inventory levels.
- [x] Enhancing cash flow.
- [ ] Raising debt-to-equity ratio.
- [ ] Increasing profit margins.
> **Explanation:** Improvements in the Accounts Receivable Turnover ratio can directly influence and enhance a company’s cash flow by ensuring faster collection of receivables.
Thank you for engaging with our comprehensive guide on Accounts Receivable Turnover and participating in the challenging quiz. Continue enhancing your financial knowledge and skills!
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