Accounts Receivable Turnover

Accounts Receivable Turnover Ratio Meaning

The accounts receivable turnover ratio indicates how effectively a business collects credit from its debtors. It is calculated by determining how frequently a business collects its average accounts receivable over a specified time period.

A higher accounts receivable turnover ratio is desirable since it indicates a shorter time delay between credit sales and cash received. On the other hand, a lower turnover is detrimental to a business because it shows a longer time interval between credit sales and cash receipts. Additionally, there is always the possibility of not recovering the payment.

Providing a line of credit is one thing, but collecting this ‘interest-free loan’ from the debtors is another.

Accounts Receivables Turnover Ratio

Accounts Receivable Turnover Formula

Accounts Receivable Turnover is calculated by dividing the net credit sales with the average accounts receivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.read more. 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

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For eg:
Source: Accounts Receivable Turnover (wallstreetmojo.com)

Accounts Receivable Turnover Ratio Formula = (Net Credit Sales) / (Average Accounts Receivable)

In the above ratio, we have two components.

  • Net Credit Sales = Gross Credit Sales – Returns (or Refunds). We need to keep in mind that here we can’t take the total net sales. We need to separate the cash sales and credit sales. And then, we need to deduct any sales return related to the credit sales from the credit sales.
  • Average accounts receivables – To find out the average accounts receivables (net), we need to consider two elements – Accounts Receivables (Opening) Accounts Receivables (Closing) and find the average of the two.

Calculation Examples

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

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

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

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 salesNet Credit SalesNet credit sales is the revenue generated from goods or services sold on credit excluding the sales discount, sales allowance and sales return. It even amounts to the accounts receivables for a certain accounting period.read more. 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

This article has been a guide to Accounts Receivables Turnover Ratio. Here we discuss its formula, calculations, interpretation along with examples. You may also refer to the following articles to learn more about Financial Ratios.

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