What Does It Mean if a Company’s Accounts Receivable Turnover Is Very High? Chron com

It is also an important indicator of a company’s financial and operational performance. A high accounts receivable turnover indicates an efficient business operation or tight credit policies or a cash basis for the regular operation. Whereas, a low or declining accounts receivable turnover indicates a collection problem from its customer. When you hold onto receivables for a long period of time, a company faces an opportunity cost.

Secondly, the ratio enables companies to determine if their credit policies and processes support good cash flow and continued business growth — or not. By comparison, LookeeLou Cable TV company delivers cable TV, internet and VoIP phone service to consumers. All customers are billed a month in advance of service delivery, thereby preventing any customer from receiving services without paying the bill. In other words, its accounts receivables are better protected as service can be disconnected before further credit is extended to the customer.

Tracking Your Accounts Receivable Turnover

In the fiscal year ended December 31, 2017, there were $100,000 gross credit sales and returns of $10,000. Starting and ending accounts receivable for the year were $10,000 and $15,000, respectively. John wants to know how many times his company collects its average accounts receivable over the year. In financial modeling, the accounts receivable turnover ratio is used to make balance sheet forecasts.

The time it takes your team to prepare and send out invoices prolongs the time it will take for that invoice to get to your customer and for them to pay it. A high AR turnover ratio generally implies that the company is collecting its debts efficiently and is in a good financial position. A useful tool in managing and improving accounts receivable Turnover ratio indicates how many times the accounts receivable have been collected during an accounting period receivable turnover is the Flash Report.

• Versapay’s AR automation solution allows your customers to raise any issues by leaving a comment directly on their invoice.
• Although numbers vary across industries, higher ratios are often preferable as they suggest faster turnover and healthier cash flow.
• Low receivable turnover may be caused by a loose or nonexistent credit policy, an inadequate collections function, and/or a large proportion of customers having financial difficulties.

Investors could take an average of accounts receivable from each month during a 12-month period to help smooth out any seasonal gaps. AR turnover ratio is also not especially helpful to businesses with a high degree of seasonality. For one, because AR turnover ratio represents an average, any customers that either pay uncommonly early or uncommonly late can skew the result. Industries like manufacturing and construction typically have longer credit cycles (e.g., 90-day terms), which makes lower AR turnover ratios normal for companies in those sectors. Since sales returns and sales allowances are outflows of cash, both are subtracted from total credit sales.

A low asset turnover ratio indicates that the company is using its assets inefficiently to generate sales. An efficient company has a higher accounts receivable turnover ratio while an inefficient company has a lower ratio. This metric is commonly used to compare companies within the same industry to gauge whether they are on par with their competitors. It tells you that your collections team is effectively following up with customers about overdue payments. A high ratio also indicates that the company has a generally strong customer base, as customers tend to pay their invoices on time. A receivables turnover ratio is a financial ratio that measures a company’s ability to turn its receivables into cash.

How Does Accounts Receivable Turnover Ratio Affect a Company?

It is also useful for monitoring the overall level of working capital investment, and so is commonly presented to the treasurer and chief financial officer, who use it to plan funding levels. For example, if the company’s distribution division is operating poorly, it might be failing to deliver the correct goods to customers in a timely manner. As a result, customers might delay paying their receivables, which would decrease the company’s receivables turnover ratio. Companies with more complex accounting information systems may be able to easily extract its average accounts receivable balance at the end of each day. The company may then take the average of these balances; however, it must be mindful of how day-to-day entries may change the average. Similar to calculating net credit sales, the average accounts receivable balance should only cover a very specific time period.

• A low AR turnover indicates that a company’s receivables are not being effectively managed and that the company is not collecting payments from its customers in a timely manner.
• Businesses hoping to secure funding or receive credit will want to ensure their receivables turnover is in a healthy place.
• For instance, if your average collection period is 41 days but your payment terms are net 30 days, you can see customers generally tend to pay late.
• In the fiscal year ended December 31, 2017, there were $100,000 gross credit sales and returns of $10,000.

It’s useful to compare a company’s ratio to that of its competitors or similar companies within its industry. Looking at a company’s ratio, relative to that of similar firms, will provide a more meaningful analysis of the company’s performance rather than viewing the number in isolation. For example, a company with a ratio of four, not inherently a “high” number, will appear to be performing considerably better if the average ratio for its industry is two. As such, the beginning and ending values selected when calculating the average accounts receivable should be carefully chosen to accurately reflect the company’s performance.

What Does It Mean if a Company’s Accounts Receivable Turnover Is Very High?

Another limitation is that accounts receivable varies dramatically throughout the year. These entities likely have periods with high receivables along with a low turnover ratio and periods when the receivables are fewer and can be more easily managed and collected. The receivables turnover ratio is just like any other metric that tries to gauge the efficiency of a business in that it comes with certain limitations that are important for any investor to consider. By proactively notifying your customers about their payment with personalized communications, you improve your chances of getting paid before receivables become overdue and speed up receivable turnover. With Versapay, you can deliver custom notifications automatically and direct customers to pay online, eliminating much of your team’s need for collections calls.

Therefore, a low or declining accounts receivable turnover ratio is considered detrimental to a company. That’s because it may be due to an inadequate collection process, bad credit policies, or customers that are not financially viable or creditworthy. A low turnover ratio typically implies that the company should reassess its credit policies to ensure the timely collection of its receivables.

Accounts Receivable Turnover Ratio

Some companies use total sales instead of net sales when calculating their turnover ratio. When evaluating an externally-calculated ratio, ensure you understand how the ratio was calculated. And, because receivables turnover ratio looks at the average across your entire customer base, it doesn’t allow you to home in on specific accounts that might be at risk of default. To get this level of insight, you’ll want to create an accounts receivable aging report. But, because collections can vary significantly by business type, it’s always important to look at your turnover ratio in the context of your industry and how it trends over time. The most common method is to divide the number of days in a period by the number of invoices outstanding at the end of that period.

A low turnover ratio represents an opportunity to collect excessively old accounts receivable that are unnecessarily tying up working capital. Low receivable turnover may be caused by a loose or nonexistent credit policy, an inadequate collections function, and/or a large proportion of customers having financial difficulties. It is also quite likely that a low turnover level indicates an excessive amount of bad debt.

Working toward and attaining financial security requires businesses to understand their accounts receivable turnover ratio. This efficiency ratio takes an organization’s receivable balances and receivable accounts into consideration to determine the state of its cash flow. The accounts receivable turnover ratio is one metric to watch closely as it measures how effectively a company is handling collections. If money is not coming in from customers as agreed and expected, cash flow can dry to a trickle. Accounts receivable turnover ratio calculations will widely vary from industry to industry. In addition, larger companies may be more wiling to offer longer credit periods as it is less reliant on credit sales.

Industry averages for accounts receivable turnover ratio

Kokemuller has additional professional experience in marketing, retail and small business.

At the other end of the list, the industries with the lowest ratios were financial services (0.34), technology (4.73), and consumer discretionary (4.8). For our illustrative example, let’s say that you own a company with the following financials. For more tips on how to optimize your accounts receivable, download your free A/R Checklist below. Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007.