How to Calculate and Improve Your Accounts Receivable Turnover Ratio

How to Calculate and Improve Your Accounts Receivable Turnover Ratio

How do some companies appear to have rapid growth… then suddenly slow down? They’re probably failing to track the right metrics.

Ensuring a systematic and efficient collection process is key to keeping cash coming into your business — just as vital as making sales and providing your products or services.

One important metric you should be tracking to gauge the health of your accounts receivable processes is accounts receivable turnover.

Need help calculating your key A/R metrics? Have a look at our free spreadsheet.

What Is an Accounts Receivable Turnover Ratio?

Also known as “receivable turnover” or “debtors turnover,” accounts receivable turnover shows the average collection period for credit — or services — you’ve extended to customers.

Tracking this metric helps you assess the efficiency of your accounts receivable and collections processes. It shows how long you take to collect on debt and invoices when you issue credit and services to a customer.

Tracking this number helps you assess the efficiency of your collections and make improvements where needed. It also helps you make revenue forecasts by considering the length of time it takes to collect on revenue earned.

How to Calculate Your Accounts Receivable Turnover 

You calculate the ratio annually by dividing net sales by average receivables for a set period. For example, for one year:

1. Net annual credit sales = Credit – sales returns – sales allowances

2. Average accounts receivable = (Start-of-year receivables + end-of-year receivables)/2

3. Net annual credit sales / average accounts receivable = accounts receivable turnover ratio

Accounts Receivable Turnover Example

For example, if your net sales for the year is $100,000, and your average accounts receivable for the year is $10,000 (start of year: $8,000 and end of year: $12,000), then your A/R turnover ratio is 10/1 or 10.

To figure out your average collection period from this ratio, divide the number of days in the period by the A/R turnover. In this example, the number of days is 365, so your average collection period is:

365 / 10 = 36.5 days

Accounts Receivable Turnover vs. DSO

Note that A/R turnover isn’t quite the same as DSO (days sales outstanding).

DSO is simply a measurement of the number of days on average it takes you to get paid after issuing an invoice.

The simplest way to calculate DSO is:

(Accounts receivable at the end of the period / Gross revenue for the period) x Days in the period = DSO

For example, if your A/R at the end of a year is $12,000, and your gross revenue for the year is $100,000, DSO looks like this: 

(12,000 / 100,000) x 365 = 43.8 DSO

What’s a Good Accounts Receivable Turnover Ratio?

There’s no perfect answer for what’s a good versus bad receivables turnover ratio. 

A desirable A/R turnover ratio is generally high. That indicates a short collection period and that you have an efficient and effective collection process.

A lower ratio could indicate that your company is liberal with extending credit and/or inefficient at collections. Generally, the higher ratio indicates a more fiscally stable and responsible company, but you may decide a lower ratio is OK to capture sales ahead of competitors or keep customers in tough economic conditions.

What makes a good ratio varies widely by industry, as well. To give you a benchmark, here are recorded ratios by industry sector as of Q1 2021, reported by CSIMarket.com:

Within your own company, think less about “what is a good or bad number,” and focus more on the trend. If your ratio dips suddenly or consistently drops each month or year, take a look at your collections processes to find opportunities to improve efficiency.

How to Improve Your Accounts Receivable Turnover

To improve your accounts receivable turnover ratio, you simply have to shrink the amount of time it takes you to get paid.

Some ways to improve your accounts receivable collections include:

• Use a consistent invoicing system. Make sure customers know when to expect to be billed and how they’ll receive their invoice. This helps them plan for their cash flow and pay on time. 

• Create clear invoices. If customers can’t interpret their invoices, they’ll have a harder time paying what they owe on time. Make sure your invoices are clear, so they know what they’re looking at and can easily confirm the services you’re charging for.

• Simplify reminders. Spare customers a slew of reminders for every outstanding invoice, and create a system that sends reminders at the account level. That lets a customer see their full outstanding balance all in one place and easily pay at once.

• Offer flexible payment options. Make it easy for customers to pay on time by being flexible with your terms to meet their needs. Also offer multiple ways to receive payment, and make it easy to pay online as soon as they receive the invoice by using an electronic invoicing and payment system.

• Offer early-payment discounts. Incentivize customers to pay invoices before they’re due by offering a discount. This encourages more customers to pay on time, and early payments can offset late payers and improve your A/R turnover.

• Be proactive about collections. Hire a dedicated person or team to handle accounts receivable and stay on top of communications regarding billing and collections, so this process doesn’t fall by the wayside.

• Use a dashboard for better visibility. A dashboard that automatically tracks and reports your accounts receivable metrics can help you easily see how your A/R turnover is trending. At Upflow, we offer solutions that let you see a real-time view of your accounts receivable metrics to improve your collections' efficiency and make more accurate financial projections.