Definition
Receivables Turnover Ratio measures the effectiveness of a company in managing and collecting its accounts receivable. This ratio indicates how many times a company’s receivables are converted to cash in a given period, typically a year. It is calculated by dividing net credit sales by the average accounts receivable.
\[ \text{Receivables Turnover} = \frac{\text{Net Credit Sales}}{\text{Average Accounts Receivable}} \]
Examples
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Company A has net credit sales of $1,000,000 and average accounts receivable of $200,000.
\[ \text{Receivables Turnover} = \frac{1,000,000}{200,000} = 5 \]
This means that Company A collects its receivables 5 times a year.
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Company B has net credit sales of $1,200,000 and average accounts receivable of $400,000.
\[ \text{Receivables Turnover} = \frac{1,200,000}{400,000} = 3 \]
This indicates that Company B collects its receivables 3 times a year.
Frequently Asked Questions
What does a high receivables turnover ratio indicate?
A high receivables turnover ratio indicates that a company collects its receivables more frequently, suggesting strong credit policies and efficient collection processes.
What are the implications of a low receivables turnover ratio?
A low receivables turnover ratio may indicate issues with a company’s credit policies, efficiency, and might suggest difficulties in collecting outstanding accounts receivable.
How can a company improve its receivables turnover ratio?
To improve its receivables turnover ratio, a company can tighten its credit policies, accelerate its collection processes, and offer discounts for early payments.
Why is the receivables turnover ratio important?
The receivables turnover ratio is important because it provides insights into a company’s cash flow management and operational efficiency.
Is it better to have a higher or lower receivables turnover ratio?
Generally, a higher receivables turnover ratio is considered better as it indicates efficient collection and management of receivables. However, extremely high ratios might also indicate overly restrictive credit policies.
- Accounts Receivable: Money owed by customers to a company for goods or services that have been delivered or used but not yet paid for.
- Net Credit Sales: Total sales made on credit, excluding any returns or allowances.
- Average Accounts Receivable: The average amount of receivables outstanding during a specific period, usually calculated as (Beginning Accounts Receivable + Ending Accounts Receivable) / 2.
- Collection Period: The average time it takes for a company to receive payment from its customers, often expressed in days.
Online References
Suggested Books for Further Studies
- Financial Statement Analysis and Security Valuation by Stephen H. Penman
- Accounting for the Numberphobic: A Survival Guide for Small Business Owners by Dawn Fotopulos
- Financial Accounting: A Managerial Perspective by R. Narayanaswamy
Fundamentals of Receivables Turnover: Accounting Basics Quiz
### Which formula correctly calculates the receivables turnover ratio?
- [ ] Net Income / Average Accounts Receivable
- [x] Net Credit Sales / Average Accounts Receivable
- [ ] Average Accounts Receivable / Total Assets
- [ ] Total Sales / Accounts Receivable
> **Explanation:** The receivables turnover ratio is calculated as Net Credit Sales divided by Average Accounts Receivable. This ratio measures how efficiently a company collects its receivables.
### A high receivables turnover ratio indicates which of the following?
- [x] Efficient collection of receivables
- [ ] Poor credit management
- [ ] High interest on loans
- [ ] Low sales volume
> **Explanation:** A high receivables turnover ratio indicates efficient collection processes and effective credit policies, meaning the company collects receivables frequently.
### Which statement is true regarding a low receivables turnover ratio?
- [x] It may suggest inefficiencies in collection processes.
- [ ] It indicates high collection efficiency.
- [ ] It is a sign of strict credit policies.
- [ ] It suggests the company has no credit sales.
> **Explanation:** A low receivables turnover ratio may suggest inefficiencies in the company's collection processes or lenient credit policies.
### How can a company improve its receivables turnover ratio?
- [x] Tighten credit policies and accelerate collections.
- [ ] Offer more credit to customers.
- [ ] Increase sales prices significantly.
- [ ] Extend payment terms to customers.
> **Explanation:** Tightening credit policies and accelerating collections can help a company improve its receivables turnover ratio by reducing the average outstanding receivables.
### The receivables turnover ratio is especially important because it provides insight into what?
- [ ] Employee performance
- [x] Cash flow management
- [ ] Fixed asset utilization
- [ ] Inventory levels
> **Explanation:** The receivables turnover ratio provides important insights into a company's cash flow management and efficiency in collecting receivables.
### What effect does a high receivables turnover ratio have on a company's cash flow?
- [x] It improves cash flow.
- [ ] It deteriorates cash flow.
- [ ] It has no effect on cash flow.
- [ ] It reduces income.
> **Explanation:** A high receivables turnover ratio typically improves a company's cash flow by ensuring faster collection of receivables.
### If a company has average receivables of $250,000 and net credit sales of $1,000,000, what is its receivables turnover ratio?
- [ ] 2
- [ ] 3
- [x] 4
- [ ] 5
> **Explanation:** The receivables turnover ratio is calculated as Net Credit Sales / Average Accounts Receivable. Therefore, $1,000,000 / $250,000 = 4.
### If a company's receivables turnover ratio improves, what might that indicate?
- [ ] Sales have decreased.
- [ ] The company is facing liquidity issues.
- [ ] Customers are taking longer to pay.
- [x] The company is collecting receivables more frequently.
> **Explanation:** An improvement in the receivables turnover ratio may indicate that the company is collecting receivables more frequently, suggesting more efficient credit and collection processes.
### What does the receivables turnover ratio fail to account for?
- [ ] Company's profitability
- [ ] Inventory management
- [ ] Employee productivity
- [x] Customer payment habits variability
> **Explanation:** While the receivables turnover ratio measures the frequency of collecting receivables, it does not account for the variability in individual customer payment habits.
### If a company's average accounts receivable increases but net credit sales stay the same, what happens to the receivables turnover ratio?
- [x] It decreases.
- [ ] It increases.
- [ ] It remains the same.
- [ ] It doubles.
> **Explanation:** If the average accounts receivable increases while net credit sales remain constant, the receivables turnover ratio will decrease, indicating slower collection of receivables.
Thank you for exploring the concept of receivables turnover with us and challenging yourself with our quiz. Keep advancing your knowledge in accounting and financial management!
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