Why Accounts Receivable Turnover is Important for Your Business
The Accounts Receivable Turnover (ART) ratio, also known as the debtor’s turnover ratio measures how efficiently a company is collecting revenue. Stretched further, it measures how efficiently a company is using its assets.
You may consider using ART as a "North Star" metric. It measures the number of times a year a business collects its average accounts receivables. It looks at how effective you are able to provide credit and collect payments in a timely manner.
A high ratio is ideal and shows that you:
- You are paid regularly and have positive cash flow
- Your customers are paying off accounts quickly, which enables them to make future purchases
- You’re not taking on as much bad debt
- Your collections methods are effective
Conversely, a low ratio means:
- Your collections operations are not effective.
- Your customers may have difficulty making payments and are less likely to make additional purchases
- Bad debt reduces cash flow
- You are extending credit too easily
Accounts Receivable Turnover Ratio formula
ART can be calculated by:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
For this purpose, Net Credit Sales are considered sales where payment is collected at a later date. It is calculated by:
Sales on Credit - Sales Returns - Sales Allowances = Net Credit Sales
Average Accounts Receivable can be calculated for a specific time period by:
Starting Accounts Receivable + Ending Accounts Receivable / 2
The higher the number, the more effective you are. Creating an A/R Aging Report is considered a best practice. It tracks and measures the payment status of all your accounts.
Why is the Accounts Receivable Turnover Ratio useful?
It provides a simple snapshot of the customer payment process and shows where issues may lie.
It’s useful for:
- Forecasting cash flow - It lets you know how liquid you are and raises flags of potential future issues
- Identifying ineffective billing - Customers not paying on time may or may not be completely their responsibility. Is your billing department doing what it can to streamline the process for them? Are you creating unnecessary friction in the process?
- Assessing your credit policy - Are your providing customers credit too easily? Too strictly? The ART will help you identify the sweet spot for extending customers a line of credit.
It’s not the end all, be all, of course. An uncommon score doesn’t tell you much by itself. It needs to be investigated to ascertain the “why” of the score. You need to determine the root cause for the ART going up or down.
Generally, the ART should only be used to compare yourself within your own industry. There are too many factors that can impact it to make it a reliable metric in comparison to non-competitors.
How to Improve Accounts Receivable Turnover Ratio
The easiest and most immediate step you may take is to ensure that your payments platform is providing your customers what they want. Are you making the process easy for them? Is it helping you keep track of your collections operation? Are you automating the process when possible?
You’ll want to ensure that invoices are sent quickly and efficiently. Having the bill in your customer’s hands will (hopefully) spur them to pay on time.
Incentives are another useful tool. Provide a reduced interest rate when a customer signs up for automatic payments or free shipping for customers with a clean account history.
Lastly, have an automated chasing strategy. Having a reasoned and researched customer communications plan will spur them to action, get you paid quicker and increase the potential for future sales.
The ART you how quickly your customers are paying their accounts. It also provides insights into your A/R process and credit policy and how effectively your billing department and platform are collecting on invoices.
Interested in automating A/R to improve your ART? Schedule a demo today!