Accounts receivable is important for every business: You need to get paid. But have you thought much about your accounts receivable turnover ratio? This number—which is easy to calculate—can give you enormous insight into just how effective your process really is, including telling you how quickly you’re getting paid.
What Is the Ratio?
The accounts receivable turnover ratio tells you how often your team is collecting accounts, on average, throughout the year. To calculate it, simply take your net credit sales (available on your income statement) and divide it over your accounts receivable (which should be stated on your balance sheet).
The resulting number is how many times your accounts were collected in the last year.
What Does It Mean?
Essentially, the turnover ratio number tells you how many times your team collected on your accounts—how many times you got paid—in the last year. If the number is high, that’s a good sign! A high number indicates your accounts were collected very regularly and frequently.
High numbers often result from a combination of a conservative credit policy and good collections. Your team extends credit only to those customers who pass rigorous screening and meet strict standards, creating a high-quality customer base for your firm. If someone does happen to fall behind on payments—which is rare—your team follows up quickly.
A low number indicates the inverse: You might be extending credit to customers who shouldn’t qualify or you may not be following up on overdue accounts in an efficient and effective manner.
Higher Ratio, Faster Payments
As a general rule of thumb, it’s safe to assume if your turnover ratio is high, you’re getting paid relatively quickly. Most of your customers pay on time, all the time; missed payments and overdue accounts are relatively rare. When they do happen, your team is able to get the account settled in short order.
A low number may mean your customers are taking too long to pay—and getting away with it. If the accounts aren’t being regularly collected, there’s a good chance many of them are becoming overdue—and being allowed to be overdue for months.
A low turnover ratio is harmful for a business. It means you’re not getting paid as soon as you should be, which hurts your cash flows and your revenues. It can also mean you need to rely on credit more heavily and have an increased risk for defaulting on your own obligations.
Fixing Low Ratios
The good news is you can do something about low ratios. If your team is struggling to get everything done, you might consider outsourcing your management or adding another staff member. You could upgrade your technology, since newer programs and infrastructure can help your team complete tasks faster.
You may also want to reconsider your policies and procedures. Are you extending credit to customers who shouldn’t qualify? Consider tightening up your credit policy. You could also encourage customers to pay early by offering them a discounted price or by making the penalties for overdue payments harsher.
Why You Need Better Accounts Receivable
You need to carefully manage how quickly and how often you get paid. Accounts receivable is considered an asset to a business, but only on paper. In practice, an inability to collect spells trouble; you might be unable to manage your own financial obligations without turning to credit. With spotty cash flows, you might even risk missing your own payments. It’s a precarious position.
If you’re having trouble managing your accounts receivable, turn to the experts and get a helping hand by outsourcing.