Receivables Turnover Ratio
Candlefocus EditorThe accounts receivable turnover ratio is calculated by dividing the net credit sales of a company by the average accounts receivables during the period of time being measured. The accounts receivable turnover ratio is most commonly expressed as the number of times a company is able to convert outstanding receivables into cash within a year. A turnover ratio of five or higher, is considered a sign of a healthy business and efficient accounts receivable.
For investors, the accounts receivables turnover ratio can be a helpful measure of a company’s financial health. A high ratio suggests the company does a good job of collecting accounts receivables in a timely manner, which indicates a strong liquidity position. On the other hand, a low ratio may indicate an inefficient collection or credit policy, or suggest that customers aren’t able to pay as consistently.
In addition, investors and financial analysts should take caution when analyzing companies' receivables turnover ratios and should pay particular attention to the methodology being used by the company. A company’s accounts receivables turnover ratio can differ drastically depending on whether the company is using net or total sales. If a company is using total sales in its accounts receivables turnover ratio calculation, the ratio will be inflated, giving a false impression of the company’s financial health.
Overall, the accounts receivable turnover ratio is an important metric to consider when evaluating a company’s liquidity and financial health. It is essential that investors carefully examine how the company calculates its accounts receivable turnover ratio, both in terms of net and total sales. This can help investors differentiate between companies that are efficiently converting outstanding receivables into cash, and those that are inflating their receivables turnover ratio numbers.