What It Measures
The number of times in each accounting period, typically a year, that a company converts credit sales into cash.
Why It Is Important
A high turnover figure is desirable because it indicates that a company collects revenues effectively, and that its customers pay bills promptly. A high figure also suggests that a company’s credit and collection policies are sound.
In addition, the measurement is a reasonably good indicator of cash flow, and of overall operating efficiency.
How It Works in Practice
The formula for accounts receivable turnover is straightforward. Simply divide the average amount of receivables into annual credit sales:
Receivables turnover = Sales ÷ Receivables
If, for example, a company’s sales are $4.5 million and its average receivables are $375,000, its receivables turnover is:
4,500,000 ÷ 375,000 = 12
Tricks of the Trade
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It is important to use the average amount of receivables over the period considered. Otherwise, receivables could be misleading for a company whose products are seasonal or are sold at irregular intervals.
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The measurement is also helpful to a company that is designing or revising credit terms.
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Accounts receivable turnover is among the measures that comprise asset utilization ratios, also called activity ratios.
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