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Bank Promotion Exams |
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Accounts Receivable Turnover Ratio It's an efficiency ratio or activity ratio that measures how many times a business can turn its accounts receivable into cash during a period. In other words, the accounts receivable turnover ratio measures how many times a business can collect its average accounts receivable during the year. A turn refers to each time a company collects its average receivables. This ratio shows how efficient a company is at collecting its credit sales from customers. Some companies collect their receivables from customers in 90 days while other take up to 6 months to collect from customers. In some ways the receivables turnover ratio can be viewed as a liquidity ratio as well. Companies are more liquid the faster they can covert their receivables into cash. Accounts receivable turnover is calculated by dividing net credit sales by the average accounts receivable for that period. Formula Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable The reason net credit sales are used instead of net sales is that cash sales don't create receivables. Only credit sales establish a receivable, so the cash sales are left out of the calculation. Average receivables is calculated by adding the beginning and ending receivables for the year and dividing by two. In a sense, this is a rough calculation of the average receivables for the year. Example Babu's Ski Shop is a retail store that sells outdoor skiing equipment. Babu offers accounts to all of his main customers. At the end of the year, Babu's balance sheet shows 20,000 in accounts receivable, 75,000 of gross credit sales, and 25,000 of returns. Last year's balance sheet showed 10,000 of accounts receivable. Find the Accounts Receivable Turnover Ratio. The first thing we need to do in order to calculate Babu's turnover is to calculate net credit sales and average accounts receivable. Net credit sales equals gross credit sales minus returns (75,000 – 25,000 = 50,000). Average accounts receivable can be calculated by averaging beginning and ending accounts receivable balances ((10,000 + 20,000) / 2 = 15,000). Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable = 50000 / 15000 ................................. |