In this lesson, you’ll learn the purpose of the receivables turnover, the formula and which financial statements to use to find the data. We’ll also discuss the usefulness in calculating the turnover by the number of days.
What Is Receivables Turnover?
Have you been to an electronics store when someone has purchased a large ticket item, such as a TV? When the customer arrives to checkout, the cashier asks, cash or credit? Customers have two options to pay for an item, they can pay cash or charge the purchase and pay for the item over time, this is called credit.When a business extends credit they create accounts receivables. Accounts receivable are monies owed to the company when they allow customers to pay for purchases over a specified period of time.The receivables turnover calculates how efficiently a company collects those payments from customers by taking credit sales divided by accounts receivable.
You’ll need to use the balance sheet and income statement to find the credit sales and accounts receivable. We’ll also discuss the usefulness of calculating the receivables turnover in days.
How to Calculate Receivables Turnover
Receivables turnover is calculated through this ratio: credit sales/accounts receivable.The numerator is credit sales, which can be found on the income statement. It’s important to make sure you use the credit sales line item.
Sometimes a company may consolidate cash and credit sales together listing only total sales. In this instance, you may have to review the annual report to obtain the credit sales number.The denominator of the ratio is accounts receivable, which can be found on the balance sheet.
Receivables Turnover Analysis
Let’s say a company has $500,000 in credit sales and $100,000 in accounts receivable. This would equal this:$500,000/$100,000 = 5In the above example, the receivables turnover of 5 means the company collects account receivables 5 times per year. It shows how efficiently the company collects payments from its customers.
Hence, the receivables ratio is categorized as an efficiency ratio.To accurately analyze the receivables turnover, it’s important to compare it to a prior period, industry average or competitor. While a 5 may be acceptable to one industry, it may be unacceptable to another. However, in general, the higher the receivable turnover, the more times a company collects payment from credit purchases.
Receivables Turnover in Days
We can take the calculation a step further and show how many days it takes to collect payments.The number of days it takes to collect payments from customers can be easier to understand. To calculate receivables turnover in days, we take 365 days in a year divided by the receivables turnover of 5 which equals 73 days (365/5 = 73).
In sum, our customers pay us every 73 days. Again, depending on the type of business, 73 days may or may not be acceptable.
The receivables turnover tells us how often the company collects payments from their customers. The ratio is calculated by taking credit sales divided by accounts receivable. You will need to use the income statement to find credit sales and the balance sheet to find accounts receivable.
The turnover is expressed by how many times customers pay their accounts; however, you may find calculating the number of days more useful.