WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Free Tutorials
  • Certification Courses
  • 250+ Courses All In One Bundle
  • Login
Home » Investment Banking Tutorials » Financial Statement Analysis » Accounts Receivable Turnover

Accounts Receivable Turnover

Accounts Receivable turnover, also known as debtors turnover, calculates that how many times business collects the average accounts receivable per year and it is used for the purpose of evaluation of the efficiency of the company to provide a credit facility of its customer and its timely collection.

What is Accounts Receivable Turnover?

It is an efficiency ratio that indicates how times a company is able to collect its average receivables in a given period. Providing a line of credit is one thing, but collecting this ‘interest-free loan’ from the debtors is another.

It estimates a firm’s effectiveness with which it collects the credit from its debtors.

Accounts Receivables Turnover Ratio

How to Calculate Accounts Receivable Turnover?

Accounts Receivable Turnover is calculated by dividing the net credit sales with the average accounts receivable. It is to be noted that net credit sales are considered instead of net sales, the reason being that net sales include cash sales as well, but cash sales do not fall under credit sales.

Accounts Receivables Turnover

  • Accounts Receivable Turnover Ratio Formula = (Net Credit Sales) / (Average Accounts Receivable)
  • Net Credit Sales = Gross Credit Sales – Returns (or Refunds)

Accounts Receivable Turnover Example

Suppose, in the year 2010 a company had a gross credit sale of $1000,000 and $200,000 worth of returns. On the 1st of January 2010, the accounts receivable were $300,000 and that on 31st December 2010 were $ 500,000

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course

Based on the above information:

  • Average Accounts Receivable = (3,00,000 + 5,00,000) / 2 = Rs. 4,00,000
  • Net Credit Sales = 10,00,000 – 2,00,000 = 8,00,000
  • Receivable Turnover = 8,00,000 / 4,00,000 = 2

Form the above example, the turnover ratio is 2, which means that the company is able to collect its receivables twice in the given year or once in 182 days (365/2).

In other words, when a credit sale is made, it will take the company 182 days to collect the cash from the sale.

Interpretation

  • Usually, the higher turnover ratio is preferred as it indicates the company’s efficiency to collect its receivables.
  • A higher ratio means that the company is collecting cash more frequently and/or has a good quality of debtors. It, in turn, means the company has a better cash position, indicating that it can pay off its bills and other obligations sooner. Many times, the accounts receivable turnover are posted as collateral for loans, making a good turnover ratio essential.
  • At the same time, a high turnover ratio may also mean that the company transacts mainly in cash or has a strict credit policy.
  • A lower ratio may mean that either the company is less efficient in collecting the creditor, has a lenient credit policy, or has a poor quality of debtors.
  • Looking at just the number (turnover ratio) doesn’t give the complete picture. It is better to check for the turnover ratio trends over the years to assess the true collecting efficiency of the companies. Many prudent analysts analyze if the company’s ratio is affecting its earnings. It is also useful to compare the turnover ratios of two companies in the same industry.

Accounts Receivables Turnover of Colgate

  • Now that we have seen how to calculate the asset turnover ratio let us see how the turnover ratio is for Colgate.
  • We have assumed here that all the Sales on Colgate’s Income statement is Credit Sales.
  • The following image shows the calculation of average receivables turnover of 2014 and 2015

Colgate Receivables Turnover

  • Colgate’s accounts receivables turnover has been high at around 10x for the past 5-6 years.
  • Higher Turnover implies a higher frequency of converting receivables into cash.

Receivable Turnover - Ratio Analysis Colgate 1

How is Colgate accounts receivables turnover ratio as compared to P&G and Unilever?

Colgate vs PG vs Unilver

  • We note that P&G Receivable turnover ratio of around 13.56x is higher than that of Colgate (~10x)
  • Unilever’s Receivables turnover is closer to that of Colgate.

 

Precautions While Using this Ratio

As an investor, care should be taken how the company has calculated the turnover ratio. Many firms consider gross credit sales rather than net credit sales. It can be misleading if attention is not paid.

Also, as stated above, the average receivable turnover are calculated by taking only the first and last months into consideration. It may not give the correct picture if the accounts receivables turnover has drastically varied over the year. To overcome this shortcoming, one can take the average over the whole year, i.e., 12 months instead of 2.

Accounts Receivable Turnover Video

 

Recommended Articles

This article has been a guide to Accounts Receivables Turnover. Here we discuss accounts receivables turnover calculation, its interpretation along with practical examples of Colgate and its comparables. You may also refer to the following articles to learn more about Financial Ratios.

  • Is Accounts Receivable an Asset?
  • Accounts Receivable–Debit or Credit?
  • Accounts Receivable Journal Entry
  • Accounts Receivables Factoring
0 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Free Ratio Analysis Course

Step by Step Guide to Calculating Financial Ratios in excel

New Year Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) View More