The accounts receivable turnover ratio is one of the most prominent accounting transactions on which companies’ sales strategies are based, and based on it, what the company is doing wrong is determined to fix it. What is the accounts receivable turnover rate, and how does it determine the sales errors that the company makes? How can this percentage be calculated? This is what we learn about in our article, along with examples of its application, so follow along with us.
What is meant by the accounts receivable turnover ratio?
The Receivable Turnover Ratio is an accounting description of the period that passes until the company’s customers pay their dues, or, in other words, it is a measure to determine the period during which the company can obtain its money due as a result of providing goods or services using the deferred payment method.
Using the receivables turnover ratio helps the company change its sales policies if necessary and evaluate its customers because standing on that ratio evaluates its financial and commercial performance. A low or high ratio has multiple connotations. Based on the evaluation of the ratio, decisions are made that would completely change the company’s policy and keep it as it is or develop it and create new payment options that make it easier for the customer to obtain services with payment facilities.
Accounts receivable in any institution are considered loans that the customer obtains and is obligated to repay on a specific date. Although this type of account is not based on paying the price of the products in instalments or adding interest to the original price, the customer may not have to pay until a month or more has passed since purchasing the product.
The accounting department calculates the turnover ratio for specific accounting periods. It may be calculated monthly, every 3 months, or even every year, in order to decide whether customers are reliable or not and determine the extent of the company’s profit or loss from following this procedure.
Types of accounts receivable turnover rate
Accounts receivable include several types of ratios and rates, and these rates are summarized as follows:
Total Receivables Turnover
It is concerned with calculating the percentage by which the company recovers its dues by measuring all accounts during a specific period, and its calculation equation is the total value of sales ÷ the average value of accounts receivable.
Net Receivables Turnover
It is calculated to determine the appropriateness of how the company recovers its money, after excluding provisions, and is calculated by the equation (total financial receivables minus financial receivables allocations) ÷ average receivables.
Days Sales Outstanding (DSO)
It is used to know the number of days it takes customers to pay, which means clarifying a time frame for the company to collect its money and knowing the period during which payment is expected to evaluate the company’s performance and develop financial plans based on that.
Quick Receivables Turnover
It is used to analyze the financial collection process in the organization and find out whether it is fast or slow. To calculate it, we use the equation Total Sales ÷ Average Accounts Receivable.
Industry-Specific Receivables Turnover Rate
It means the rate that is measured by knowing the average turnover of accounts receivable in other companies operating in the same field in which your company operates.
The importance of the accounts receivable turnover ratio
Periodic calculation of the accounts receivable turnover ratio is important and necessary for business continuity, as companies depend on it to improve cash flow and make it more beneficial to them. It is also used to increase the company’s efficiency and its ability to collect receivables from its customers within a short time. Many benefits highlight the importance of the receivables turnover ratio, which are as follows:
Developing credit policies
This means enabling the company to set a few conditions that customers must adhere to to obtain the goods with payment later, such as imposing guarantees or the like. This is also useful in improving financial flow by developing new strategies that will motivate customers to pay on the scheduled dates without delay.
Reducing risks
Measuring the accounts receivable turnover ratio is useful in ascertaining whether or not customers can pay on time. This makes the company more careful when dealing with customers who may not be able to pay, which causes it to suffer losses that could have been avoided.
Measuring efficiency in financial transactions
The efficiency of the company’s money management is verified, which means consolidating its financial options and performance in dealing with accounts receivable, or preventing its policies and changing them to more efficient policies in collecting receivables if the payment rate in accounts receivable is not consistent with expectations.
Improve the ability to make decisions.
With the results that the company’s management recognizes, it can make more efficient and better financial and production decisions, enhancing the production and sales processes. The company is also able to organize better relationships with suppliers and customers so that it can obtain the best possible benefit from its sales policies.
Boost confidence
When a company achieves a high accounts receivable turnover ratio, it gains the trust of investors who grant it financing that helps it expand the business and develop better. Therefore, measuring this ratio and recording the results is necessary because of its impact on the future of the company as a whole.
Factors affecting the accounts receivable turnover rate
There are a few factors that will improve the receivables turnover ratio so that the company can recover its money within the agreed-upon date without delay affecting its results negatively, and these factors are:
Payment Terms
As long as the company sets conditions that are achievable and easy to adhere to, it will be able to collect its money on the agreed-upon date, but the company must understand its customers to set a payment condition that suits them, and they must become committed to the required date and not be late for it. Here, the company can allow long-term payment, but with conditions that guarantee payment at the scheduled times.
Type of Activity
The activity in which the company operates may determine the turnover rate of its accounts receivable from the beginning. If the company produces expensive goods, it often needs long-term payment plans and may be exposed to the problem of delaying payment at higher rates than companies that produce low-cost goods.
Customers
The company must choose its customers whom it allows to buy and pay over long periods and only allow this to be done to those who are trusted because as long as the customer is reliable and committed to paying within the scheduled dates, the company will be safe from a low turnover of accounts receivable.
How to calculate the accounts receivable turnover ratio
There is an equation that can be used to calculate the accounts receivable turnover ratio, which is as follows:
Accounts receivable turnover ratio = total credit sales ÷ average accounts receivable
In this equation, total credit sales refer to the value of the goods that the company sold during the period being measured, deducting the deductible values from them.
The average receivables mean the value that constitutes the receivables that are due during the measurement period, and by dividing it by the total for sales, the final turnover ratio is arrived at.
Examples of accounts receivable turnover ratios
Below, we provide several examples that illustrate how to apply the equation for calculating the receivables turnover ratio. These examples are as follows:
First example
| If Al-Ghamdi Furniture Trading Company achieved sales worth 1,800,000 riyals during one year, including accounts receivable worth 900,000 riyals at the beginning of the year, and it decreased to 500,000, then the turnover ratio of its accounts receivable is as follows: Accounts receivable turnover ratio = net credit sales ÷ average accounts receivable Total sales = 1,800,000. Average accounts receivable = (value of accounts receivable at the beginning of the year + value of accounts receivable at the end of the year) ÷ 2 = (900000 + 500000) ÷ 2 = 700000 So accounts receivable turnover ratio = 1,800,000 ÷ 700,000 = 2.5 This indicates that the company receives its payments approximately every two months. |
Second example
| Khaled Al-Tamimi, a doctor specializing in jaw and dental surgeries, accepts long-term payments for his clients who have health insurance from certain companies, while those who do not have insurance coverage are only allowed to pay in cash. Within 6 months, he achieved operations and follow-ups worth 750,000 riyals for his clients, with an average receivables value of 80,000 riyals. Accordingly, his receivables turnover rate during those 3 months is as follows: · Accounts receivable turnover ratio = net credit sales ÷ average accounts receivable Therefore, the accounts receivable turnover ratio is 750,000 ÷ 80,000 = 9.3. This means that the rate at which he received his dues was nine times during that period, which is a high rate, but he may face a risk resulting from the strictness of the payment policy that he follows. |
What is the relationship between accounts receivable and profits?
The higher the accounts receivable turnover ratio, the more profits the company can achieve in its sales operations because customers pay the money owed on schedule. This means that this money will go into new production processes or circulate in the company’s financial departments, keeping its business going and its profits thriving. However, a low percentage causes a decrease in profit because late payment of funds affects the company’s business and may lead to the loss of a large portion of capital, not to mention the loss of investment opportunities. This means that it will not be able to develop its business or open new projects.
Is high turnover better than low turnover?
Yes, an increase in this ratio is better than a decrease, and before I tell you the reasons, let us learn together about two basic concepts related to the accounts receivable turnover ratio, which are:
High Accounts Receivable Turnover Ratio
It is the ratio that indicates that the company has good credit policies that help it recover the amounts due on the scheduled dates, and it also indicates that it deals with reliable customers who are committed to the scheduled payment dates.
Low Accounts Receivable Turnover Ratio
This ratio is undesirable because it indicates that there is a problem either in the credit policies followed by the company or in the customer base that it deals with, as they are not committed to paying on time and the company is unable to collect its money due on the scheduled dates because of this.
Looking at these two definitions, we see the following:
| Comparison | High accounts receivable turnover rate | Low receivables turnover rate |
| Business process | It helps her maintain it and grow the business. | It causes the company’s business growth to stop due to a lack of funding. |
| Investment | It increases the company’s chances of obtaining it and makes it an attractive and reliable destination for investors. | It causes a lack of investments and prevents investors from investing in it because the low percentage of accounts receivable turnover makes it an unsafe investment destination. |
| Customers | The ratio indicates a high rate of commitment and trust in customers. | The ratio reflects the presence of a base of unreliable customers who do not adhere to the financial decisions imposed on them. |
| capital | The company’s capital can be preserved, and its investment opportunities can be enhanced in the best possible way with a high accounts receivable turnover rate. | Capital is damaged and depreciated faster with continued slow collection of receivables, which may expose the company to bankruptcy in the long term. |
Ways to improve the accounts receivable turnover ratio of institutions
There are a few tips that, when taken into consideration, enable you to obtain higher turnover rates, and the company becomes better in its sales policies and collection of receivables. These tips include the following:
Establish clear terms of payment.
You must be confident that the payment terms you offer are understandable and clear to customers and that they are consistent with the dates or agreements established to regulate the payment process.
Use different payment methods.
The more the customer can pay in convenient ways, the easier his commitment to payment will be, so you must select more than one payment method to suit all customers who benefit from your services and buy your products.
Offering advance payment benefits
If the customer benefits from discounts or additional offers when paying in advance, he will be keen to take advantage of these offers and will not resort to deferred payment except when he encounters circumstances that force him to do so. Thus, you will see a significant decrease in long-term payments and a demand for advance and cash payments.
Reminding customers of payment dates
You should send out emails at certain times before payment deadlines to remind your customers of their payments, but you must be careful when using this feature so that customers do not consider you annoying.
Issuing accurate and regular invoices
It is necessary to send invoices to customers on time without delay to ensure that customers pay what they owe on the specified dates. As long as invoices are not sent, customers will be late, so you must be regular in sending them and clarifying the payment details in them.
Advantages of measuring the account turnover ratio through the accounting system
When you use the Qoyod accounting program to calculate the accounts receivable turnover ratio, you will benefit from many advantages, including the following:
- Determine how long each customer is late in paying the money he owes without the need for effort and time.
- Recording all transactions as soon as they are completed, in addition to mentioning the details of the transactions and agreed-upon dates.
- The turnover ratio of financial receivables is calculated, and its information is collected and analyzed smoothly and without the need to scrutinize paper books.
- The system can be accessed from multiple devices without posing a risk to the information saved in your account.
- You can use the Qoyod system to send automatic reminders to customers to alert them to the payment due date.
Conclusion
In the end, we explained to you everything related to the accounts receivable turnover ratio, including details that will interest you. Companies depend on the accounts receivable turnover rate to be able to evaluate their buying and selling strategies. Thus, it maintains safe financial limits that help it continue to operate without risks, and it helps you greatly in evaluating your company if you take the initiative to join the users of the Qoyod accounting system from major companies and commercial institutions that have been able to follow their accounting performance over the years, which has made a significant difference in their results and progress. So try Qoyod for free for 14 days and see the result for yourself.
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