What is Accounts Receivable Turnover?
Accounts receivable turnover is the number of times per year that a business collects its average accounts receivable. Accounts receivable turnover are used by accountants and analysts to measure how efficiently companies collect on the credit that they provide their customers.
How to Calculate Accounts Receivables Turnover Ratio?
Diving deeper into the definition of accounts receivables turnover, it is a ratio of average accounts receivable for a period divided by the net credit sales for that same period.
The turnover ratio can give insights on:
- How your company is handling credit policy and practices
- How your company is managing customer debt.
High Turnover Ratio
Having a high turnover ratio is a good sign for your company. This means that your company’s collection processes are effective in receiving payments for debts on time, which in turn increases cash flow making room for future purchases. Ultimately, you are extending credit to the right kind of customers, meaning, your company won’t take on as much debt. Contrast high turnover ratio with a lower turnover ratio, where you have customers who do not pay on time.
Low Turnover Ratio
A low ratio turnover can cause cash flow issues for your business. Although, this kind of turnover can tell you which areas can be improved, this could mean you’re giving credit too leniently and customers are struggling to make payments on time or at all. When you have poor collection methods or are simply extending credit to unqualified customers, bad or uncollectible debt can and will hurt your cash flow.
By closely tracking your accounts receivables you can find opportunities for your business to improve their credit policy, receivable practices, and ultimately the company’s bottom line.
Why do Accounts Receivables matter?
Managing accounts receivables can be difficult, but it’s an important part to managing any business. Making sure your cash flow is steady and not approaching worrisome levels is essential to make sure your business continues in the right direction. Failure to properly manage your accounts receivable could lead to several problems:
- Missed payments: A client forgets or neglects to pay his bills, but because you’re not properly tracking your accounts receivable, you don’t notice the lack of incoming revenue.
- Lack of cash flow: Without cash, your business could fail to pay overhead costs, meet payroll, or take advantage of an opportunity that presents itself.
Accounts Receivables Turnover Best Practices
1) Know your A/R Turnover Ratio
To calculate the accounts receivable turnover, start by adding the beginning and ending accounts receivable and divide it by 2 to calculate the average accounts receivable for that specified period. Take that figure and divide it into the net credit sales for the year for the average accounts receivable turnover. The formula should look like the ones below:
- Beginning accounts receivable + ending accounts receivable / 2 = net accounts receivable
- Net credit sales / accounts receivable = accounts receivable turnover
As stated previously, having a low number is equivalent to your business not getting paid and incurring debt. Higher numbers mean higher collection ratios, which means your customers are paying on time and keeping your cash flow steady.
2) Create an Accounts Receivable Aging Report
Accounts are determined by the number of days since the invoice was issued. Your business can effectively track your customers payment status using an accounts receivable aging report. An aging report shows accounts receivables aged out in terms of days past due. For example an aged A/R of 45 days means that invoice is 45 days past due. This is a great method for spotting any early collection issues before accounts become more than a few days past due.
3) Offer Incentives
Offering incentives can be another useful tool/strategy in managing accounts receivables turnover. Incentives don’t have to be over the top expensive. It could be something as little as a 2% discount if the customer pays within 30 days, small gifts, or free shipping and delivery.
Motivating your customers through incentives can make all the difference in getting your customers to pay their outstanding balance off sooner. These are a few options that can happen when your business offers incentives:
- increase the likelihood of your customers paying you
- increase your accounts receivables turnover
- increase your cash flow
- increase business efficiency
4) Follow up with Customers
A rule of thumb to business success is keeping track and staying on top of invoices. Follow up, follow up, follow up; we can’t stress enough how important it is to remind your customers of their payments due. By sending an invoice reminder after a certain period of time reminding the customer that their invoice is due greatly increases your odds of not only getting paid but getting paid more quickly.
A/R automation takes the traditional process and transfers this so-called administrative burden to the world of technology. A/R automation automatically creates and sends out invoices at specified times and dates. Automations can help insure that your customers received the invoice and can help your business get paid faster, which in turn means a high turnover ratio and consistent cash flow.
6) Define Credit Terms
Design clear credit policies for your customers and follow through with them. For example, you can request payments within a net 30 day period and don’t be afraid to include late fees in your policies. Late payment fees should include a percentage of the original invoice amount.
Additionally, making modifications to your current policies can help adjust to new environments. For example, you could reduce the time frame a customer gets to pay their dues, but this entails sending invoices on time as well as consistently monitoring your accounts receivables turnover ratio on a daily basis so that you can follow through with your new policy.
7) Improve Collection Efficiencies
Efficiency is key. If you can find a way or ways to help collect what is owed then everything else, such as accounts receivables turnover ratio and cash flow, will increase significantly. Some ways of improving efficiency include:
- A lockbox where customers have a secure place to drop off their checks
- pre-authorized checks allow you to collect funds automatically on a regular basis
- Set-up direct deposit with your clients
8) Collect Past Due Receivables Quickly
The longer a receivable goes uncollected the less likely it is that it will ever be collected. Your business must act quickly as soon as you notice a receivable going past due by even one day. The client must be contacted on the first day the payment is due. You can use tactics such as reminding your client of any late penalties they may incur as clearly stated in your payment terms. Communication can range from letters to emails in order to remind the client of any consequences that can be taken if payments have not been received by a set date.
Having open communication with your clients can certainly build stronger customer relationships. Ultimately, with such a tight knit relationship you can get to the bottom of why the payment was late to begin with and try to avoid any mishaps in the future.
Summary: Managing Accounts Receivables Turnover
Accounts receivables are one of those tasks that can appear daunting, but it’s essential to helping you and your customers stay consistent with their payments. Increasing your accounts receivables turnover can help your business run more efficiently and take the stress of low cash flow issues off your plate.
Managing, monitoring, and improving your accounts receivables process is the key to a healthier cash flow. Tracking receivables can help you spot trends, and you can use that information to improve your collection methods.