AR TURNOVER RATIO HIGH LOW HOW TO

On the other hand, if credit is too lax, not only will there be more late payments, but bad debt write-offs will increase.Ī low AR turnover ratio might also point beyond credit and collections. If credit requirements are too strict, a very high percentage of customers may pay on time, but the strictness of credit means you are excluding potential customers and losing sales. Of course, there is tension in granting credit and timely collection of money owed. Further, you are not extending credit to your slow and no-payers, nor are they likely in a position to buy. However, a low AR turnover ratio suggests you may be too lenient in granting credit and inefficient in collections, hurting your cash flow. When customers pay debts timely, you can open their credit and perhaps increase their limit for more sales. In addition, it suggests that you are extending credit to a suitable customer base and that your collection methods are effective. The benefits of a high AR turnover ratio include receiving timely payments, increasing cash flow and enabling you to meet your obligations. Other sectors such as the financial industry have comparatively long payment terms. Some industries demand swift turnover, such as fuel, shipping, and agriculture. So comparative interpretation and benchmarking depends on the industry. And the AR turnover ratio varies by industry and business model. Your own standard terms provide a baseline to interpret your ratio. However, if your standard terms are 15 days, an AR turnover ratio of six is poor. For example, if your standard terms are 60 days in the example above, an AR ratio of six is excellent. The AR turnover ratio gives a company an idea of when accounts receivable will be paid and suggests the strength of the company’s credit and collections, though it can also point to problems such as product or fulfillment problems.Īs noted, a higher turnover ratio is better a lower ratio is indicative of problems with collection efficiency and possibly inadequate review of creditworthiness. The Meaning of the Accounts Receivable Turnover Ratio So, an accounts receivable turnover ratio of 6 indicates, on average, you are turning over AR every 61 days. Using the example above, conversion to days is: To do this, divide the number of days in the year by the AR turnover ratio to see the average time in days. To get a quick grasp of the ratio, it helps to convert it to days. $150 million / $25 million = 6 AR Turnover Ratio Converting the A/R Turnover Ration to Days Accounts receivable at the start of the year was $25.5 million, and at the end of the year, $24.5 million.

To illustrate, supposed your company had net credit sales of 150 million last year. So Accounts Receivable Turnover = Net Credit Sales / AR AverageĪR Average =

Average Accounts Receivable ( add two Accounts Receivable totals, from the start and end of the year, and divide by 2 to get your average AR).

Net Credit Sales ( all annual credit sales, minus returns and allowances).

The AR turnover ratio tells you the number of times your average AR balance turns over in the period measured (typically a year)-how quickly you collect on accounts receivable.

The Meaning of the Accounts Receivable Turnover Ratio.

Converting the A/R Turnover Ration to Days.

The Accounts Receivable Turnover Formula.

In contrast, a low ratio indicates problems in collections and possibly weak credit policy or review. A high accounts receivable turnover rate demonstrates the efficiency of collections based on adequate credit vetting. The higher the rate, generally, the better.

The AR turnover ratio effectively measures the effectiveness of your credit decisions and debt collection. One way to do so is to review your accounts receivable turnover ratio. Rarely if ever, do all customers pay every creditor on time, so finance must keep an eye on accounts receivable turnover. Complexity underlies that simple concept, however. Companies extend credit to customers and expect to get paid within a specified time after shipping their products or delivering their services.

AR TURNOVER RATIO HIGH LOW HOW TO

Read this blog to understand what it means, how to calculate it, and how to improve it.Ĭredit is a normal part of doing business.

There are several important metrics for accounts receivable (AR). Metrics tell you important information about your enterprise’s performance.

Ar turnover ratio high low