Are late payments from customers slowing down your business? Is it suffering from piled-up invoices and dried-out cash flow? Whether you’re unable to release inventory, extend new credit, or even cover day-to-day expenses, poor collection efficiency can have profound ripple effects across your entire organization.
These issues often stem from inefficiencies in your accounts receivable process. According to a June 2023 PYMNTS survey, 81% of businesses reported increased delayed payments, and 77% of AR teams fell behind on their metrics.
That’s why understanding and tracking your receivables turnover ratio is not just important, but critical. This key metric helps you measure how effectively your business collects payments and whether your cash inflows align with your credit terms.
This article will explain the receivables turnover ratio, how to calculate it, and what the results mean for your cash flow, credit policies, and financial health. You’ll also get access to actionable tips to enhance your AR turnover ratio. Let’s get started.
The accounts receivable turnover ratio, sometimes called the receivables turnover ratio or the debtor's turnover ratio, is an efficiency ratio that assesses how well a business collects revenue by calculating the time it takes to collect the outstanding debt over the accounting period.
Simply, it means how often the company collects its average accounts receivable or converts AR into cash during a period (e.g., a month, quarter, or year).
The accounts receivable turnover ratio provides businesses with instant information about the effectiveness of their credit policies, the creditworthiness of their clientele, and how well their collections team is pursuing past-due payments.
Finance teams can use the AR turnover ratio to forecast the balance sheet. This enables businesses to better manage their spending by predicting how much cash they will have at hand. Moreover, ensuring a healthy AR turnover is crucial for companies seeking funding or loans.
Understanding the receivables turnover ratio and its significance is the first step towards improving your cash flow and credit management. Let’s delve into how to calculate it accurately so you can start applying it to your own AR efforts.
The AR Turnover Ratio is calculated by dividing net sales by average accounts receivable. Before diving into the formula, let’s understand how to calculate each component.
The term "net credit sales" describes how much revenue a business makes, particularly through credit. Take your gross credit sales (the total sales resulting in an accounts receivable balance), and deduct any returns from customers, sales allowances (price reductions, typically caused by accidental mispricing), or discounts.
Note: Cash sales are not included in the calculation of net credit sales.
The next step is to figure out the average accounts receivable. Add the amount of your accounts receivable at the start of the accounting period (for example, a month or quarter) to the amount at the end. Then, divide the sum by two to get the average.
Once you’ve calculated the two components, divide your net credit sales by your average accounts receivable for the same period to get your accounts receivable turnover ratio.
Accounts Receivable Turnover Ratio = Net Credit Sales ÷ Average Accounts Receivable
You can use your accounts receivable turnover ratio to calculate the average number of days that clients take to pay their invoices (for credit sales). This is also called the average collection period or days sales outstanding (DSO). Here's how to figure it out:
Accounts Receivable Turnover In Days = 365 ÷ Accounts Receivable Turnover Ratio
Pro Tip: Track your AR turnover days to see if customers pay on time. For example, if your average collection period is 41 days but your terms are net 30, it clearly shows that most customers are paying late. Use this insight to adjust credit policies, follow-up timing, or incentives for early payment.
Let’s walk through an example to see how it works in practice.
XYZ Industrial Supplies, a mid-sized B2B distributor, recorded net credit sales of $720,000 for the year. They have a standard net 30 payment term. Their accounts receivable were $40,000 on January 1; by December 31, it stood at $50,000. Therefore,
This means XYZ Industrial Supplies collects and converts its receivables into cash 16 times a year on average.
With an average collection period of approximately 23 days, XYZ collects payments faster than its net 30 terms. This reflects strong AR performance and consistent cash flow, which is ideal for reinvesting in inventory and operations.
Did You Know? Usually, a DSO below 45 is considered ideal for your average collection period. However, since receivables turnover can vary significantly depending on the type of business you run, no hard and fast rule determines whether it is "good" or "bad."
Now that you’ve seen how the receivables turnover ratio is calculated, let’s understand how to interpret the results and what they reveal about your collections performance.
A high receivables turnover ratio means your company collects payments quickly and efficiently. This often indicates a reliable customer base and a strict and well-managed credit policy.
On the other hand, a low turnover ratio can signal problems, such as delayed collections or poor credit control. It can also result from offering overly generous credit terms just to boost sales—this may help short-term revenue, but creates a long-term risk of bad debts. Remember, the longer you wait to collect, the less that money is worth.
Also Read: Successful Strategies for Bad Debt Collection
Pro Tip: Regularly track your turnover ratio against industry benchmarks to spot red flags early and adjust your credit strategy before cash flow suffers.
Example: If your ratio is 4, and the industry average is 2, you're still ahead—even if 4 doesn’t seem very high individually.
Lower AR turnover ratios are common in industries like manufacturing and construction due to longer credit cycles (such as 90-day periods). High turnover ratios are frequently found in sectors like retail, where payment is typically needed upfront or the collection cycles are relatively quick.
The above bar graph showcases the highest (retail) and lowest (financial) AR turnover ratios by industry. The data is based on research conducted by CSIMarket.
While the receivables turnover ratio offers valuable insights into your collection efficiency, it's essential to understand its limitations to avoid drawing incomplete or misleading conclusions.
While the accounts receivable turnover ratio is a valuable metric for assessing collection efficiency, its limitations can affect accuracy and applicability. Here are the key limitations to consider:
Pro Tip: To understand which customers are struggling, look at accounts receivable aging reports.
Is your business struggling with slow payments and inefficient accounts receivable management? Let South East Client Services inc (SECS inc) help you improve your AR turnover ratio by implementing proven strategies. We’ll ensure that your collections process is efficient, reducing delays and boosting cash flow.
While understanding the limitations of the receivables turnover ratio is essential, improving it is key to maintaining healthy cash flow. Let’s explore some actionable tips to boost your AR turnover ratio.
If your AR turnover ratio is low, it’s time to refine your credit and collection policies. Here are some actionable strategies to boost your ratio and streamline your AR process:
Also Read: Solving Top Accounts Receivable Challenges
By adopting these strategies, your business can improve receivables turnover ratio, accelerate cash flow, and reduce collection costs, ultimately creating a healthier financial position.
Understanding how to calculate and interpret the accounts receivable (AR) turnover ratio is vital for any business looking to improve its cash flow and collection efficiency. While it offers valuable insights, it’s also important to acknowledge its limitations and take proactive steps to improve it through better invoicing, flexible payment options, and effective collection practices.
South East Client Services inc (SECS inc) specializes in helping businesses optimize their receivables management. With 10+ years of experience, our team of experts can guide you in calculating and analyzing your AR turnover ratio, ensuring more predictable cash flow while identifying potential areas for improvement.
Contact South East Client Services inc (SECS inc) today to take control of your delinquent accounts receivable and enhance your AR turnover ratio!
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