Receivable turnover is a measure of how quickly a company is collecting its sales that were made on credit (i.e., 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. Factors impacting receivable turnover include:
- Credit terms. 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.
- Billing accuracy. 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.
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)
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).
For example, 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).
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.