How to Compute Receivable Turnover
Receivable turnover is a crucial financial metric that provides insights into a company’s efficiency in collecting payments from its customers. It is an essential indicator of a company’s liquidity and financial health. Calculating receivable turnover involves a straightforward formula that can help businesses assess their performance in managing accounts receivable. In this article, we will explore how to compute receivable turnover and its significance in financial analysis.
Understanding Receivable Turnover
Receivable turnover, also known as accounts receivable turnover, measures how quickly a company collects payments on its credit sales. It indicates the number of times a company’s accounts receivable are collected and replaced over a specific period. A higher receivable turnover ratio suggests that a company is efficient in collecting payments, while a lower ratio may indicate potential issues with credit management or slow payment habits among customers.
Formula for Computing Receivable Turnover
To compute receivable turnover, you need two pieces of information: net credit sales and average accounts receivable. The formula is as follows:
Receivable Turnover = Net Credit Sales / Average Accounts Receivable
Calculating Net Credit Sales
Net credit sales refer to the total sales made on credit during a specific period, excluding any returns, allowances, or discounts. To calculate net credit sales, you can use the following formula:
Net Credit Sales = Total Credit Sales – Sales Returns – Sales Allowances – Sales Discounts
Calculating Average Accounts Receivable
Average accounts receivable is the average amount of accounts receivable over a specific period. To calculate it, you need the beginning and ending balances of accounts receivable for that period. The formula is as follows:
Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2
Example Calculation
Let’s consider a company with the following information:
– Total Credit Sales: $1,000,000
– Sales Returns: $50,000
– Sales Allowances: $20,000
– Sales Discounts: $10,000
– Beginning Accounts Receivable: $100,000
– Ending Accounts Receivable: $150,000
First, calculate net credit sales:
Net Credit Sales = $1,000,000 – $50,000 – $20,000 – $10,000 = $920,000
Next, calculate average accounts receivable:
Average Accounts Receivable = ($100,000 + $150,000) / 2 = $125,000
Finally, compute the receivable turnover:
Receivable Turnover = $920,000 / $125,000 = 7.36
This means that the company collected its accounts receivable 7.36 times over the period.
Significance of Receivable Turnover
Receivable turnover provides valuable insights into a company’s financial performance. A high receivable turnover ratio suggests that the company is efficient in collecting payments and has a strong credit policy. Conversely, a low ratio may indicate potential issues, such as a lenient credit policy, slow payment habits among customers, or inefficient collection efforts.
In conclusion, computing receivable turnover is a simple yet essential process for businesses to assess their financial health and efficiency in managing accounts receivable. By understanding the formula and significance of this metric, companies can make informed decisions to improve their credit management and overall financial performance.
