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Measuring a company’s ability to collect sales on credit from its customers by estimating the number of times Accounts Receivable were collected from customers during a length of time or period.[sc:kit02 ]
Accounts Receivable Turnover Formula
Explanation of Accounts Receivable Turnover
The Accounts Receivable Turnover measures the number of times Accounts Receivable were collected during a period. This period can be any length of time, such as monthly, quarterly, or yearly. The Accounts Receivable Turnover ratio is also a measure of how well the company can collect sales on credit from its customers. The Average Collection Period is a similar measurement, and estimates the average number of days it takes for a company to collect on its credit sales.
Accounts Receivable Turnover is found by adding the starting and ending values of accounts receivable, then dividing by two. The Net Sales is then divided by this average Accounts Receivable value. Another way to write this equation is:
[ (Starting Accounts Receivable + Ending Accounts Receivable) / 2]
Importance of Accounts Receivable Turnover
A high, or increasing Accounts Receivable Turnover is usually a positive sign – showing the company is successfully executing its credit policies and quickly turning its Accounts Receivable into cash. Being able to efficiently collect on its credit sales is important for any company, and each company has to find a balance between extending credit to other companies to encourage more sales, yet not be too forthcoming with credit, as the sheer number of credit accounts can become a problem when trying to manage all of them.
A possible negative aspect to an increasing Accounts Receivable Turnover is the company may be too strict in its credit policies and missing out on potential sales. Although companies may play it safe and restrict credit sales to prevent abuse, a better approach would be to evaluate potential companies wishing to receive sales on credit and start with smaller credit values. Once companies have gained a reputation of keeping their promise, the company extending credit can increase the amount of credit.