How To Calculate Receivables Turnover Ratio (With Examples)

Receivables turnover ratio = (Net sales on credit / Average receivables)

When companies extend credit to customers, they collect payments from accounts receivable. While it's beneficial to allow customers to purchase products and services on credit, it can affect the receivables turnover ratio. This ratio measures the average rate at which companies collect payments due from clients and can tell you about profitability.

In this article, we explore what the receivables turnover ratio is, why it's an effective metric to use and how to calculate it, with examples to help you apply the formulas.

What is the receivables turnover ratio?

The accounts receivables turnover ratio measures a business's ability to collect on payments its customers owe for products or services. If your company lets customers make large purchases on credit, the receivables turnover ratio is an effective metric for evaluating how quickly the company collects on extended credit and short-term payments. This accounting metric is also an important indicator of how effectively companies manage customer credit accounts, as the ratio provides insight into whether companies extend too much credit.

To find receivables turnover, apply the formula:

(Receivables turnover ratio = Net sales on credit / Average receivables)

In the formula, the net credit sales value represents the total amount of credit sales your company makes over a specific period. The average receivables value is the average amount the receivables account collects in the same period. Dividing these two values gives you the receivables turnover ratio.

Related: What Is Accounts Receivable Turnover?

Why use the receivables turnover ratio?

Using the accounts receivable turnover ratio is effective because it tracks the average rate customers make payments for credit purchases. Businesses that collect from accounts receivables extend credit to their customers according to specific payment terms. Typically, companies establish payment terms according to 30-, 60- or 90-day periods. At the end of these payment terms, the accounts receivable collects what customers owe. Knowing how quickly the receivables collect on owed credit can help sales and accounting teams improve billing processes. Measuring the receivables turnover ratio is also useful for several more applications, including:

Measures efficiency of cash conversion

When companies collect on accounts receivables and credit payments, they commonly calculate these values as cash assets. The receivables turnover ratio can give you valuable insight into how efficiently your organization is able to convert sales revenue to income. When evaluating the turnover ratio for accounts receivable, it's also helpful to calculate the asset-turnover ratio to better understand incoming cash flow activities.

Helps identify developing trends

Analyzing the turnover ratio for receivables can also help sales and finance teams identify emerging trends in customer sales. For instance, a company can monitor the turnover ratio to observe patterns that can indicate increases or decreases in sales, especially credit sales. Additionally, you can also measure the ratio of your company's receivables to income to better understand how its extension of customer credit affects profitability. The ability to identify trends is also important for developing strategies that help improve receivables turnover.

Gives investors insight into profitability

The receivables turnover rate can also show investors how your company's rate compares with competitors in the market. This information allows them to evaluate the profitability and ability of your company to continue growth. Investors who see companies with higher receivables turnover ratios may be more willing to accept the financial risk of funding them.

Related: What Is Accounts Receivable and How Does It Work?

How to calculate the receivables turnover ratio

Use the receivables turnover ratio formula and the following steps to calculate the receivables turnover ratio:

1. Calculate the average accounts receivable

Determine what the average value of your company's accounts receivable is for the period you're measuring. Find the balance for the beginning of the current period and the balance for the end of the period you measure. Add these two values together and divide the sum by two to get the average. You can calculate the average receivables with the formula:

[Average accounts receivable = (starting balance + ending balance) / 2]

2. Find the total amount in credit sales

To determine how much revenue your company earns from all its credit sales, subtract the total value in returns from all sales on credit. Then, subtract the sales allowances from this difference. The result is the net credit sales. The formula is an effective tool for finding this value quickly:

[Net sales on credit = (All credit sales - Total returns) - Sales allowances]

Related: How To Calculate Accounts Receivable and Related Formulas

3. Divide the credit sales by the receivables

Once you have both your average accounts receivables and the net sales on credit values, you can divide. Using the receivables turnover ratio formula, divide the credit sales by the average receivables. The result is the turnover ratio, which can provide the insight you need to evaluate the efficiency of revenue conversion to income.

What does the receivables turnover ratio tell you?

The turnover ratio can indicate several things for your company's accounts receivables. For instance, a turnover ratio that's higher indicates the company's efficiency in collecting and converting sales revenue. High turnover ratios can also show how well a company evaluates customers when extending credit. However, if the ratio is on the lower end, it could tell you that the company may need improvements to different processes in its sales activities. For instance, lower ratios can often mean a business's credit policies need evaluation to ensure payments come in a timely manner.

Related: What Is Turnover?

Examples

Use the following examples of each step of calculating the receivables turnover ratio:

Calculating net sales on credit

Assuming a technology firm extends client credit based on 30-day collection periods, financial analysts want to understand how effectively the company's receivables collect on customer payments. Before the analysts can calculate receivables turnover, though, they calculate the net sales on credit using the formula:

[Net sales on credit = (All credit sales - Total returns) - Sales allowances]

At the end of the quarter, the company's totals in credit sales, credit returns and sales allowances are $450,000, $113,000 and $68,000, respectively. The analysts find:

Net sales on credit = (All credit sales -Total returns) - Sales allowances =

Net sales on credit = ($450,000 - $113,000) - $68,000 =

Net sales on credit = $337,000 - $68,000 = $269,000

Calculating average accounts receivable

Using the same example, the analysts then determine the average accounts receivable using the formula:

[Average accounts receivable = (Starting balance + Ending balance) / 2]

Assuming the company's starting receivables balance is $410,000 and the ending balance is $385,000, the analysts calculate the average with the equation:

Average accounts receivable = ($410,000 + $385,000) / 2 =

Average accounts receivable = ($795,000) / 2 = $397,500

Related: How To Calculate Average Percentage: Formula and Examples

Calculating the receivables turnover ratio

After calculating both the net credit sales and the average accounts receivables, the analysts can use these values to determine the turnover ratio for their company's receivables. Using the formula:

[Receivables turnover ratio = (Net sales on credit / Average receivables)]

The analysts find:

Receivables turnover ratio = (Net sales on credit) / (Average receivables) =

Receivables turnover ratio = ($269,000) / ($397,500) = 0.68 = 68%

This value indicates the company's receivables turnover ratio is 68%, so for all sales on credit the company makes, 68% of client payments arrive on time. This can indicate a need for improvement or additional evaluation of clients before extending credit. In contrast, this ratio could indicate a healthy turnover rate, depending on what the industry average is for similar technology services.