Ever wondered how efficient your accounts receivable management is? If you calculate your turnover ratio, you can get a better handle on just how efficient and effective your process is—and where you can make improvements.
How do you calculate your turnover ratio? It might sound like a lot of work, but it’s actually very simple.
What Is the Turnover Ratio?
In simple terms, your accounts receivable turnover ratio is the number of times per year your accounts are collected, on average. The ratio tells you how proficient you are at collecting on credit you’ve issued to your customers.
Why do you need to know this ratio? For starters, it gives you a better idea of how well you’re doing in terms of collecting on accounts. You may think you’re doing very well, but if you’re issuing much more in credit than you’re collecting, you’ll probably realize you could step up your game to collect payments more effectively and efficiently.
Your ability to collect has a huge impact on your cash flows and revenue, as well as your business’s risk, so knowing your ratio can tell you a lot about how well your firm is performing.
Calculating Your Ratio
The calculation of the turnover ratio is relatively simple for any business. Simply take your net annual credit sales from your annual income statement and divide it over the current amount of your accounts receivable. Your accounts receivable number is located on your balance sheet.
The result is the number of times your accounts are collected in any given year.
Interpreting the Results
If your resulting ratio is high, congratulations! A high accounts receivable turnover ratio is a good thing. Generally speaking, it means your team is doing a good job of collecting accounts on a regular basis—you’re getting paid frequently and on time.
A high number often indicates good collections activity. It also says something about the quality of your customer base: Your customers pay you on time or maybe even early. This could mean your team is doing a good job of vetting customers before opening accounts; your screening process nets you a high-quality customer base.
What does a low ratio mean? There are a few takeaways from a low number. If a high result means your accounts are collected regularly, a low result means your team isn’t collecting on accounts very often—which could mean you’re not getting paid.
A low ratio could stem from a few factors. Your credit policy may be too lax; you extend credit to customers who probably shouldn’t qualify, resulting in a low-quality customer base who tends to be problematic and not pay on time. It could also mean your collections process is a little more lackadaisical; your reminder notifications don’t go out on time or your team is too swamped to follow up on overdue accounts.
Boosting a Low Result
If your turnover ratio is low, you’re probably wondering what you can do about it. There’s good news: You can take action to fix it right now.
The first thing to do is look at your process. If your team is inefficient or understaffed, accounts receivable could be falling by the wayside. Learn to prioritize this task. You might also reconsider your credit policies, implement stricter rules for extending credit, or embark on more follow-up to get overdue accounts paid sooner.
You might also consider outsourcing the task, especially if the problem is a team that’s overwhelmed and struggling to keep up with demand.