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 from its customers or clients. Stretched further, it measures how efficiently a company is using its assets.
You may consider using ART as a "North Star" metric to gauge how effective your business is at managing accounts receivable. The ART ratio measures the number of times a year a business collects its average accounts receivables, and how effective you are able to provide credit and collect payments in a timely manner.
Thus, Accounts Receivable Turnover is an important indicator of your business’s financial efficiency and effectiveness. Furthermore, you can compare your company’s ART ratio with industry peers to determine if your firm is on par with others.
To help you get a better understanding of how Accounts Receivable Turnover impacts your business, we’ve compiled everything you need to know about the subject.
Why is the Accounts Receivable Turnover Ratio Useful?
As mentioned earlier, the ART ratio is a simple and effective way to get a picture of a company’s financial efficiency and effectiveness. The ratio helps provide 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 you 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.
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
As an example, consider a business who has net credit sales of $4,000,000 over the last year, with an average accounts recievable of $400,000. To find the Accounts Receivable Turnover during the past year, you would divide $4,000,000 by $400,000 and get a result of 10.0, which means on average the company’s accounts receivables turned over 10 times during the past year (equivalent to about every 36 days).
What Is a Good Accounts Receivable Turnover Ratio?
The ART ratio you aim for should be based on the performance of your industry peers. For instance, an ART ratio of 12 may be perfectly fine for a service based business that collects monthly invoices from clients. However, a ratio of 12 may be too low for retail stores who need to collect more often.
In general, the higher your Accounts Receivable Turnover ratio is, the more efficient your company is.
A high Accounts Receivable Turnover 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 Accounts Receivable Turnover 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
You should also create an A/R Aging Report, which tracks and measures the payment status of all your accounts.
How to Improve Accounts Receivable Turnover Ratio
The easiest and most immediate step you can take to improve your ART ratio is ensuring 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. This is especially useful for businesses that offer payment plans, as billing may be in irregular intervals and customers may forget when payments are due.
Boost Your Accounts Receivable Turnover Ratio by Automating A/R
The ART ratio reveals you how quickly your customers are paying their accounts. It also provides insights into your A/R process,credit policy, and how effectively your billing department and platform are collecting invoices. If you calculated the ART ratio for your business and found it lower than industry peers, you should evaluate your A/R process to identify areas for improvement to prevent future issues.
Invoiced can help you improve your ART through our easy-to-use and comprehensive A/R automation technology. Get paid faster and spend less time on collections so you can spend more time improving the customer experience and focusing on other areas of your business. With more than $40 billion in receivables processed and thousands of satisfied customers, Invoiced is an industry leader in Accounts Receivables Automation.
Interested in automating A/R to improve your ART? Schedule a demo today!