The accounts receivable number is one of the most confusing numbers on the balance sheet to understand. It is income that is due to the company, but the company has not yet paid. So while the goods or services have been given out already, the money for them has not yet been received. This is problematic because it decreases the inventory. Meanwhile, it is increasing the expense of trying to get back the money that the company for the products. So, this is when the accounts receivable turnover needs to appear.
Because of the above numbers, it is important for companies to track how well they are able to receive their payments for debts that their customers owe. To do this, they often use the accounts receivable turnover ratio.
What Is an Accounts Receivable Turnover Ratio?
An accounts receivable turnover is the total amount of times in a fiscal period that a company is able to achieve their average amount of accounts receivable.
- It achieves this by first determining what the average amount of accounts receivable is. This number results by adding together the first and last amounts of the accounts receivables of the last fiscal year.
- Then, that total divides by two.
- After this, the net sales amount for the year appear by subtracting all refunds, returns, and cash sales from the total sales. This will leave only the sales that were put on to the accounts for later payment.
- Then, the net sales number divides by the average accounts receivable amount to finally have the accounts receivable turnover ratio.
Who Needs to Use an Accounts Receivable Turnover Ratio the Most?
Some companies only operate on a cash basis because they don’t want the hassle of having to try to collect payment from their customers later on. But others who charge large amounts for their goods and services might want to allow the option of charging at least part of the balance to an account. This is because it gives people who might not have all of the money at once a chance to still make a purchase. So, this type of company will benefit the most from keeping tabs on what this ratio is.
You can only calculate it accurately once a year because you have to first know the beginning and ending accounts receivable balances. So those who have a brand new company won’t be able to benefit from it until their company is several years old. That way, several years worth of data can compare side-by-side. Banks also look at this ratio. So, people who are trying to apply for a loan might want to point out this ratio as a way of increasing their chances of getting an approval.
How Much Is Spent on Calculating This Ratio?
As long as a company has been keeping up all of the entries on their general ledger accounts, calculating the accounts receivable turnover ratio won’t cost them a thing. It is just a matter of sitting down to do the math.
However, inaccurate accounts receivable numbers can throw things off. This means that it will take more time to figure it out. So it is important that a company always reviews their accounts first before attempting to find out what their ratio is.
3 Ways to Have a Financially Less-Demanding Ratio
The following are several basic ways to ensure that the accounts receivable ratio is possible by a company itself instead of having to pay an outside financial professional to do it for them:
- The best way to keep accounts receivable numbers accurate is to have a timely billing system. You should send all invoices should at the end of the month. Then, you should give a ten-day period for the payments to arrive. If you haven’t received payments by then, calls and letters to the customers should start right away. You should never allow customers to avoid payment for several months. Consequently, this will reduce the amount of the accounts receivable ratio.
- Reconciling on a monthly basis will also help you ensure that you can correct any possible mistakes right away. All reconciling should be done before the invoices are sent out to the customers though. That way, there will be fewer errors on their bills. Nothing is more embarrassing than having to receive calls from customers who point out that the math on their bills doesn’t add up.
- Another important thing to consider is the staff that is active in the accounts receivable process. You can shorten the amount of time that it takes to do all of the work of the process of calculating the accounts receivable turnover ratio. This is possible just by having an accountant with training on hand. Small companies who are short on funds can often hire an accountant to work part time to settle the work. Also, they train one of their employees to do all of the accounts receivable work.
It might first take a little extra time to calculate the accounts receivable turnover ratio. However, it is usually easy to figure out if a company always keeps their accounts receivable numbers reconciled. This is easy if you hire a trained accountant to do your financial calculations. And remember, all reconciling should be done on a monthly basis before before any invoices are sent out. This will reduce the risk of customers getting inaccurate bills. It will also speed up the time that it takes to receive payments. You should collect all payments at the end of the month. Never let them sit on the books because they will lower the accounts receivable turnover ratio.
Because this ratio is so important, we recommend that you print out this page to keep on hand. Also, feel free to share it on your social media pages for other companies and financial professionals who might need it. If you have had any experience using this ratio, feel free to comment below.