The accounts receivable turnover ratio calculation is done by dividing net credit sales by the average accounts receivable. It helps measure a company’s effectiveness in collecting debts and managing customer credit.
Accounts receivable turnover formula
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
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Steps to calculate:
- Calculate the net credit sales: Net credit sales are determined by deducting returns and allowances from the total gross sales. This calculation reflects the actual sales revenue that a company can expect to collect from credit sales.
Net Sales Formula = Gross Sales – Refunds/Returns – Sales on Credit
- Determine the average accounts receivable: Average accounts receivable is found by taking the sum of starting and ending receivables for a period and dividing by two, providing the average balance owed to the company during that time.
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Average Accounts Receivable Formula = (Beginning AR + Ending AR) ÷ 2
- Divide the net credit sales: To find the accounts receivable turnover ratio, divide net credit sales by the average accounts receivable.
A Sample Calculation of Accounts Receivable Ratio
Let’s take an example to understand how to calculate the accounts receivable turnover ratio. Laura, the CEO of Company A, offers credit sales to her customers. In a year, the company had gross credit sales of $200,000, but there were returns of $20,000. The accounts receivable at the beginning of the year was $20,000, and at the end of the year, it was $25,000.
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To calculate the accounts receivable turnover ratio, we need to divide the net credit sales by the average accounts receivable. The net credit sales would be the gross credit sales minus returns, which is $200,000 – $20,000 = $180,000. The average accounts receivable would be the sum of the beginning and ending accounts receivable divided by 2, which is ($20,000 + $25,000) / 2 = $22,500.
Therefore, the accounts receivable turnover ratio for Company A would be $180,000 / $22,500 = 8. This means that Company A was able to collect its accounts receivable eight times during the year.
It’s also important to calculate the accounts receivable turnover in days, which indicates how long it takes customers to repay their debt. To do this, we can use the formula: Receivable turnover in days = 365 / AR turnover ratio. So, for Company A, the accounts receivable turnover in days would be 365 / 8 = 45.63. This means that, on average, it takes customers nearly 46 days to repay their debt to Company A.
If Company A has a strict payment policy of 30 days, the accounts receivable turnover days indicate that customers are paying late. This would suggest that the company needs to improve its collection process or adjust its credit policy to ensure that customers pay on time.
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