Accounts Receivable Turnover Ratio

Definition

The accounts receivable turnover ratio is a financial metric that measures how effectively a company is managing and collecting its accounts receivable. It indicates the efficiency with which a company is able to convert its receivables into cash.

5 Must Know Facts For Your Next Test

1. The accounts receivable turnover ratio is calculated by dividing net credit sales by average accounts receivable.
2. A higher accounts receivable turnover ratio indicates that a company is more efficient in collecting payments from its customers.
3. The accounts receivable turnover ratio is an important metric for assessing a company's liquidity and the effectiveness of its credit and collection policies.
4. A low accounts receivable turnover ratio may indicate that a company is granting too much credit or is not aggressive enough in collecting payments from customers.
5. The accounts receivable turnover ratio can be used to calculate the average collection period, which represents the number of days it takes a company to collect its accounts receivable.

Review Questions

• Explain how the accounts receivable turnover ratio is calculated and what it measures.
  • The accounts receivable turnover ratio is calculated by dividing a company's net credit sales by its average accounts receivable. This ratio measures how effectively a company is managing and collecting its accounts receivable. A higher ratio indicates that the company is more efficient in converting its receivables into cash, while a lower ratio may suggest that the company is granting too much credit or is not aggressive enough in collecting payments from customers.
• Describe the relationship between the accounts receivable turnover ratio and a company's liquidity and working capital management.
  • The accounts receivable turnover ratio is an important metric for assessing a company's liquidity and the effectiveness of its credit and collection policies. A high accounts receivable turnover ratio suggests that the company is efficiently converting its receivables into cash, which can improve its overall liquidity and working capital management. Conversely, a low ratio may indicate that the company is tying up too much of its capital in accounts receivable, which can negatively impact its ability to meet short-term financial obligations and fund day-to-day operations.
• Analyze how the accounts receivable turnover ratio can be used to evaluate a company's credit and collection policies, and the potential implications for the business.
  • The accounts receivable turnover ratio can provide valuable insights into a company's credit and collection policies. A low ratio may suggest that the company is being too lenient in its credit terms or is not aggressive enough in collecting payments from customers. This can lead to a buildup of accounts receivable, tying up working capital and potentially increasing the risk of bad debts. Conversely, a high ratio may indicate that the company is being overly stringent in its credit policies, which could discourage customers and negatively impact sales. By analyzing the accounts receivable turnover ratio, management can assess the effectiveness of their credit and collection policies and make adjustments to optimize the balance between customer satisfaction, liquidity, and profitability.

Related terms

Accounts Receivable: Accounts receivable represents the money owed to a company by its customers for goods or services provided on credit.

Cash Conversion Cycle: The cash conversion cycle is the time it takes for a company to convert its investments in inventory and other resources into cash from sales.

Working Capital: Working capital is the difference between a company's current assets and current liabilities, representing the capital available to fund day-to-day operations.