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Accounts Receivables Turnover Ratio – Definition, Formula, Steps and Example



Introduction

Ratio analysis refers to the systematic use of ratios to interpret the financial statements in terms of the operating performance and financial position of a firm. It involves comparison for a meaningful interpretation of the financial statements.

In view of the requirement of ratios to be reported in a financial report, the ratios are classified into the following broad categories:

  • Liquidity Ratio
  • Turnover Ratio
  • Solvency or Leverage ratios
  • Profitability ratios

Definition of Turnover ratio?

Turnover ratios are also referred to as activity ratios or efficiency ratios with which a firm manages its current assets. The following ratios can be calculated to judge the effectiveness of the asset's use.

  • Inventory Turnover Ratio
  • Accounts Receivables Turnover ratio
  • Creditor Turnover Ratio
  • Assets Turnover Ratio

In this article, we will discuss on accounts receivable turnover ratio.

What is Accounts Receivables Turnover Ratio and how to calculate it?

Accounts Receivables Turnover ratio is also known as debtors turnover ratio. This indicates the number of times average debtors have been converted into cash during a year. The receivables turnover ratio is determined by dividing the net credit sales by average debtors.

Debtor Turnover Ratio = Net Credit Sales / Average Trade Debtors

Components of Accounts Receivables Turnover Ratio

Net Credit Sales

The aggregate amount of sales or services rendered by an enterprise to its customers on credit. The terms gross credit sales and net credit sales are sometimes used to distinguish the sales aggregate before and after deduction of returns and trade discounts. The concept of net credit sales is an indicator of the total amount of credit that a company is granting to its customers.

Average Trade debtors

A trade debtor is a person from whom amounts are due for goods sold or services rendered or in respect of contractual obligations. Also termed as a debtor, bills receivables or account receivable.

Trade debtor includes sundry debtors and bill’s receivables and the formula to determine average trade debtors is given below:

Average trade debtors ( Opening + Closing balances / 2 )

Note: When any information about credit sales, opening and closing balances of trade debtors is not available then the ratio can be calculated by dividing total sales by closing balances of trade debtor

Debtor Turnover Ratio = Total Sales / Trade Debtors

Steps to calculate Accounts Receivables Turnover Ratio

Step 1: Determine your net credit sales

The first part of the accounts receivable turnover formula calls for net credit sales, or in other words, all of the sales for the year that were made on credit (as opposed to cash). This figure should include the total credit sales, minus any returns or allowances. We should be able to find the net credit sales number in the annual income statement or Profit & Loss a/c.

Step 2: Determine your average accounts receivable

Once we have the net credit sales figure, the second part of the accounts receivable turnover formula requires the average accounts receivable.

Accounts receivable refers to the money that’s owed to a business by its customers. In order to find the average accounts receivable, we will have to take the number of your accounts receivable at the beginning of the year, add it with the value of your accounts receivable at the end of the year, and divide by two to find the average. We should be able to find the necessary accounts receivable numbers on the balance sheet.

Step 3: Apply the Accounts receivable formula.

Once we have these two values, we will be able to use the accounts receivable turnover formula. And then we will divide the net credit sales by the average accounts receivable to calculate the accounts receivable turnover ratio, or rate.

Accounts Receivables Turnover ratio example

Let’s say MAX Ltd., made 100,000 Indo rupiah in net credit sales for the year and had sales returns amounting to 20,000 Indo rupiah, with average accounts receivable of 25,000 Indo rupiah. What is the Receivables Turnover ratio of MAX Ltd?

Step 1 : Net Credit Sales = Sales ( - ) Sales returns

In the given example it works out to 80,000 Indo rupiah

Step 2: Average accounts receivable (already given in the example as 25000 Indo rupiah )

Step 3 : Divide = Net credit sales/ Average accounts receivable

In the given example, 80,000/25,000 = 3.2 (Accounts Receivables Turnover ratio)

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