Did you know 45% of new businesses fail during their first five years of being in business? If you are a new business and want to avoid being part of this statistic in the future, it is important to learn all about what is accounts receivable turnover ratio and how to calculate it.
Keep reading to learn everything you need to know about this specific ratio.
What Is Accounts Receivable Turnover Ratio?
This is the number that is used in business accounting in order to quantify how companies are managing the credit that they extend to their customers. The point is to see how long it takes a business to collect any outstanding debt from a client.
In simple terms – the accounts receivable turnover ratio will show how long it takes customers to pay on average.
How to Calculate the Accounts Receivable Turnover Ratio
The calculation will depend on whether you calculate the monthly, quarterly, or yearly time period. The Net Credit Sales are divided by the Average Accounts Receivable and it will give you the Accounts Receivable Turnover Ratio.
In order to understand the process and determine the correct number, you have to figure out your net credit sales first. This is the total sales that were made on credit (not the ones paid in cash upfront).
Then you have to determine what your average accounts receivable amount is. This is the money that your clients or customers owe you. With both of those numbers, you can divide them and find your accounts receivable turnover ratio.
The lower the number is the lower number of payment collections you have from your customers and the higher the ratio, the higher the number of payment collections.
Importance of This Ratio
One of the reasons you want to make sure you always know your own ratio is to help you determine if your credit policy and processes support good cash flow or not. Another reason is to understand how quickly your company is currently collecting payments.
Knowing this will help you pay the bills you have and will also help you place future investments strategically without going into a black hole.
Improving Your Turnover Ratio
If you find that your ratio is on the low end then you can make a few changes to help improve it. First, you can always state your payment terms. If your clients are not clear on your repayment policies, you can’t expect to enforce something you have not announced.
You want to make sure that your invoices, contracts, and agreements cover your policy clearly. You can also offer customers different ways to pay. Giving them options might make it easier for them to pay you quicker.
Feeling Like a Turnover Ratio Pro?
Now that you know the ins and outs of what accounts receivable turnover ratio is and how to calculate it, you can make informed decisions on your own company moving forward.
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