# Receivables Turnover Ratio: Formula, Importance, Examples, and Limitations

> **Definition**
>
> The accounts receivables turnover ratio measures how efficiently a company collects payment from its customers.

## What Is the Receivables Turnover Ratio?

The receivables turnover ratio measures how many times a company successfully collects its average [accounts receivable](https://www.investopedia.com/terms/a/accountsreceivable.asp) balance over a certain period (usually a year). This ratio helps companies monitor cash flow by quantifying the effectiveness of their payment collection efforts.

### Key Takeaways

*   The receivables turnover ratio measures how often a company is collecting its accounts receivable balance from customers over a certain time period.
*   Companies use this ratio to measure how often they’re converting outstanding customer credit into cash.
*   A high ratio suggests effective collection, while a low ratio indicates potential issues with credit collection.

![Receivable Turnover Ratio](https://www.investopedia.com/thmb/RWD3zWG8X7C1N396UMUPjf1rTvw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/receivableturnoverratio-8f6c3aac6494463a8e6cdd011e236fbe.jpg)

*— Investopedia / Zoe Hansen*

## Understanding Receivables Turnover Ratios

To calculate the receivables turnover ratio, a company needs to divide its [net credit sales](https://www.investopedia.com/ask/answers/050415/how-are-net-credit-purchases-calculated-accounts-payable-turnover-ratio.asp) by its average accounts receivable. This gives an estimate of how often a company collects its receivables. This ratio is usually calculated on a monthly, quarterly, or annual basis, and it can be used to help companies measure current [cash flow](https://www.investopedia.com/terms/c/cashflow.asp) trends and identify opportunities for improvement.  

## Understanding The Components of the Receivables Turnover Ratio

Two essential elements are needed to calculate the receivables turnover ratio: net credit sales and average accounts receivable.

![Accounts Receivable Turnover](https://www.investopedia.com/thmb/FmE4170KCdlldR115mnaXQgsq5M=/1160x0/filters:no_upscale():max_bytes(150000):strip_icc()/Capture2-7ef5868f8d454b04996dc03e72775428.JPG)

*Accounts Receivable Turnover. — WallStreetMojo*

### Net Credit Sales

Net credit sales refers to how much [revenue](https://www.investopedia.com/terms/r/revenue.asp) a company earns, specifically revenue paid as credit. The sale must incur an accounts receivable balance in order to be considered a “net credit sale,” meaning cash sales aren’t included.

To calculate net credit sales, a business takes its gross credit sales (the volume of all sales incurring an accounts receivable balance) and subtracts customer returns or discounts. This is important, because businesses will need to calculate the net credit sales during a specific period of time, often a month or quarter. If a customer returns an item outside of that period (say the following month), the return will still need to be applied to the net credit sales calculation.

For example, if Joe’s Bakery made $50,000 in gross credit sales during one month and received $1,000 in returns (even if some of those returns happened in the following month). Their net credit sales would be $49,000.

### Average Accounts Receivable

To calculate the ratio, you’ll need to know the balance of your average accounts receivable. In other words, how much do you generally maintain in outstanding customer payments? Companies can determine this amount by calculating the difference between starting accounting receivables balances and ending balances. 

Depending on the company’s [accounting software](https://www.investopedia.com/terms/a/accounting-software.asp), this information may be automatically calculated and presented—sometimes on a daily basis. It will be important to ensure the only data included in the ratio coincides with a specific time period (such as one month or quarter).  

For example, if Joe’s Bakery has an accounts receivable balance of $5,000 at the start of the month and $10,000 at the end of the month, the company would add the two balances together and divide by two to find the average accounts receivable for the month:

Average accounts receivable: ($5,000 + $10,000) / 2 = $7,500

## Example of Receivables Turnover Ratio

Company A has net credit sales of $1,000,000 for the year. On January 1, their starting accounts receivable balance was $70,000. On December 31, their ending accounts receivable balance was $85,000. 

First, calculate the average accounts receivable:**  
($70,000 + $85,000) / 2 = $77,500**

Next, let’s use the information above to determine the accounts receivable turnover ratio:**  
$1,000,000 in net credit sales / $77,000 in average accounts receivable = 12.98**

Based on the data provided during this time period, Company A collects its accounts receivables and converts that credit to cash 12.98 times on average per year.

More specifically, we can deduce:

365 days per year / 12.98 = The average duration of accounts receivable is approximately 28 days. 

If Company A has a net 30-day payment policy, a 28-day turnover ratio indicates that customers are paying about two days early on average. 

Company A can use this information to justify its customer credit structure or payment policy, as it indicates their current processes are generally effective.

## How the Receivables Turnover Ratio Correlates with Cash Flow

The time between the sale of a product or service and payment can impact [cash flow](https://www.investopedia.com/terms/c/cashflow.asp). Unless all outstanding costs are owed upfront (ex., a cash sale at a grocery store or clothing store), a business is essentially loaning customers the funds owed until it’s time to collect.

It’s not unusual for businesses to give clients 30 days or longer to pay for a product or service. That’s the time during which the business could be reinvesting in itself, [paying down debts](https://www.investopedia.com/personal-finance/digging-out-of-debt/), or otherwise addressing its own financial obligations.

The receivables turnover ratio can help a company understand its existing cash flow trend. The higher the ratio, the more efficient the company is at collecting outstanding account balances. The lower the ratio, the more inefficient they may be—meaning the company converts its accounts receivable to cash less often. 

By tracking the receivables turnover ratio, businesses can gain insight into their collection efficiency and take actions to improve cash flow, such as adjusting customer payment terms or improving credit collection strategies.

## Advantages and Disadvantages of the Receivables Turnover Ratio

While the receivables turnover ratio can help companies conduct internal comparisons to previous periods, it may be difficult to compare ratios across the industry.

Advantages

*   Provides clear insights into the efficiency of a company’s credit and collections process.
    
*   Helps monitor cash flow and identify opportunities for improving collection practices.
    
*   Useful for internal benchmarking over time.
    
      
    

Disadvantages

*   Difficult to compare across industries due to varying standards and customer credit policies.
    
*   Seasonal fluctuations can impact the ratio, requiring analysis over longer periods (e.g., 12 months).
    
*   Companies may inflate their ratio by using total sales numbers instead of net sales when calculating. 
    
*   Not all companies disclose net sales information, making it harder to get accurate comparisons.
    
      
    

## Receivables Turnover Ratio vs. Asset Turnover Ratio

The receivables turnover ratio measures a company’s ability to effectively collect outstanding payments from customers. The asset turnover ratio, however, measures how effectively a company is able to use its assets to generate revenue. In both cases, the higher the ratio, the more efficiently the company is operating.

## What Does a High Receivables Turnover Ratio Mean?

The higher a company’s accounts receivable turnover ratio, the more frequently they convert customer credit into cash. This is an indication that the company is operating efficiently and its customers are willing and able to pay their outstanding balances in a timely manner.  
  
A high ratio can also indicate that the company has relatively conservative lending practices for its customers. While this leads to greater control over cash flow, it has the potential to alienate customers who require longer payback periods.

## What Does a Low Receivables Turnover Ratio Mean?

When a company’s receivables turnover ratio is low, this indicates they have an issue with collecting outstanding customer credit and converting it into cash. The lower the ratio, the less frequently the company is collecting payments, indicating a potential cash flow problem.   
  
A low ratio could also be an indication that there’s a problem with production or product delivery—if customers aren’t receiving their products on time, they aren’t going to pay on time either. 

## Why Is the Accounts Receivable Turnover Ratio Important?

The receivables turnover ratio is one metric a company can use to glean information about customer habits and internal payment collection practices. When this data is collected, measured, and compared over time, it can help a company identify potential opportunities to either increase customer credit allowances (and, ideally, widen its customer base) or tighten credit practices and improve cash flow. 

## The Bottom Line

Most companies and corporations invoice for their services, though the terms of payment vary greatly. These variances can impact a business’s ability to meet their cash flow needs, pursue new financial ventures, and otherwise continue operating efficiently. Calculating the receivables turnover ratio regularly can help companies track their payment collection efforts and identify potential areas for improvement.

> **Article Sources**
>
> 1.  Quickbooks. "[How to Calculate Net Sales?](https://quickbooks.intuit.com/global/resources/expenses/how-to-calculate-net-sales/)"