What’s Your Accounts Receivable Turnover Ratio?
When measuring your accounts receivable efficiency, there are few metrics as helpful as your accounts receivable turnover ratio, or ART. However, like many cash flow measurements, this one can be tricky to calculate if you have the wrong formula or incorrect data.
Today, we’re taking a close look at everything you need to know about your AR turnover ratio: what it means, how to properly calculate it and how to increase it where necessary.
Accounts Receivable Turnover Ratio: What Does It Mean?
Your accounts receivable turnover ratio is a measure of how effectively you collect debt. This also provides information on your management of each credit sale and your credit terms overall. ART can be altered to fit different time periods, but the goal is always the same: It should tell you how often you gather your average accounts receivable.
What It Means
A high AR turnover ratio means that your accounts receivable efficiency is high and you can quickly collect owed payments. That’s good news for your cash flow, working capital and more.
If you’ve achieved a high AR turnover ratio, you likely have:
- Effective collection processes.
- Low-risk customers.
- Strong credit terms.
Keep in mind that a ratio doesn’t indicate the health or efficiency of any single task, workflow or team; it’s a combination of many elements and should be used as such. That means it’s often helpful to use ART in tandem with other metrics.
How It Compares
ART isn’t the only measurement that creates insight into your cash flow, average accounts receivable and more. Here’s how it compares to other AR metrics:
- Days sales outstanding (DSO): This is a measurement of how long it takes to collect payment based on invoice dates. A key difference here is that you want a low DSO but a high ART.
- Average days delinquent (ADD): ADD tracks the number of days a customer payment is overdue. It provides less context around internal processes and, like DSO, should be as low as possible.
- Collection effectiveness index (CEI): Your CEI is a bit broader than your AR turnover ratio. The former measures your effectiveness at collecting outstanding money in a given period, while the latter is more focused on the frequency at which accounts receivable turnover.
Why It Matters
A low turnover implies lenient credit terms or delays in payments slowing cash flow, neither of which is good for business. Knowing what’s driving this is key as a company may want lenient terms to drive sales when trying to enter a new market or divest of slow moving inventory. Conversely a company may want to drive down average receivables to improve cash flow by tightening terms. This process is indeed a fine balancing act.
Although a high AR turnover ratio should always be your goal, the definition of “high” may shift depending on your industry and other factors, such as seasonality. Generally speaking, however, the metric is useful for creating insight in two areas:
- Tracking your accounts receivable efficiency: If you compare ART outcomes from different periods, you can see how your cash flow and customer payment habits change over time. You can also catch any signs of trouble before they become more significant.
- Comparing your accounts receivable efficiency: If you have insight into industry averages or a competitor’s AR turnover rate, you can compare yours to see how your company measures up. This is a good way to identify challenges that could make you less agile.
No matter how you use your AR turnover ratio, it’s important to understand the formula used to calculate it and where the relevant data comes from.
The Accounts Receivable Turnover Formula
The calculation for your AR turnover rate has two basic parts:
- Net sales using credit: This should take into account every credit sale made during the specified period. (Cash sales should not be included.)
- Average accounts receivable: To find this number, take the sum of starting and ending receivables for the same period and divide by two.
Once you have these numbers, you’ll use a formula that looks like this:
ART = net credit sales ÷ average accounts receivable
The result will likely be a decimal — one that represents your turnover rate. The higher the number, the better the ratio. You can sometimes “eyeball” this formula to roughly determine whether the outcome is positive or negative for your cash flow. For example, if your net credit sales are much higher than your average accounts receivable, there’s a good chance the ratio will be high, too.
While the full ART formula is useful, it’s important to remember that it doesn’t express a number of days. For that calculation, you’ll need to do something like this:
AR Turnover in Days = (net credit sales ÷ average accounts receivable) ÷ 365
Measuring in days gives you a different view of your ART and helps you see more precise data over the year. Remember to keep track of the time periods you use for each data point, as ART can be used annually, quarterly or even monthly depending on your needs.
High vs. Low AR Ratio
You want your ART to be as high as possible. This indicates that your average accounts have a fast turnover rate and that you’re collecting on each outstanding invoice in a timely manner. The lower the ART, the more unpaid invoices you have to contend with.
What Causes a Low Ratio?
Say you ran through the turnover ratio formula multiple times, even double-checking your net sales and average AR calculations, and you still end up with a low ratio. This could be due to problems with your:
- Payment collections and invoice processes: If you have large-scale automated or manual workflow inefficiencies that slow your teams down
- Customer base: A credit-worthy customer often pays their outstanding invoice on time, boosting your ART. If, on the other hand, almost every account introduces credit risk through frequent late payments and delinquencies, this might cause ART problems.
- Credit policy: Some companies offer extended, flexible terms for every credit sale. Should each customer take advantage of this flexibility, payment times would be extended and the ART may suffer — even if invoices are technically paid when required.
The good news is that, although this apparently simple metric comes with plenty of potential challenges, there are ways to improve your ART and protect your cash flow.
Increasing Your Accounts Receivable Turnover Ratio
When working with the accounts receivables turnover ratio formula, remember that you’re seeing the outcome of many moving parts. To make meaningful improvements, you’ll need to identify the particular area of your AR workflow that needs attention.
Here are a few tips to get you started:
Accounts Receivable Automation
AR and collection automation doesn’t just eliminate delays and remove manual tasks that would otherwise interrupt your teams. It’s also an excellent tool for ensuring accuracy, consistency and simplicity in all your data extraction operations. That means you’ll have more, better data — and you’ll spend less time collecting and managing it. This reduces internal wasted time and helps boost your ART without impacting your credit policy.
Automated Reporting Software
Reporting and dashboards work together to create a real-time view of your cash flow — including DSO, DDO and Deduction activity. You’ll have clearer insight into what’s happening and when, enabling you to better prioritize invoice and payment management — which, in turn, helps boost your ART by focusing on problem areas.
Any number of things can interrupt workflows and cause invoice delays, which could lower your ART even if customers are paying on time. If you can identify where and why problems arise, you can cut out inefficiencies, implement automation solutions and encourage better habits for your AR teams. It’s particularly helpful to track data at different levels so you can “zoom in” on particular areas instead of limiting yourself to a broad view.
Customer Relationship Management
If your customers are continually taking advantage of flexible payment terms, you may need to take a more active role in measuring and managing these relationships. Of course, you don’t have to demand cash sales only — just work with your sales and marketing teams to learn more about the kinds of audiences you’re attracting and how you can better navigate their needs. For example, it may be helpful to clarify your credit policy, offer multiple payment options and set automated reminders to encourage timely payments.
Encourage ART-Friendly Behavior
An early payment is good news for your ART. So is a cash purchase, because these numbers don’t impact your ART at all. Identify these customer behaviors and encourage them through discounts, special offers and other perks. This doesn’t just help protect your accounts receivable balance and turnover ratio; it also saves money by reducing the time and effort necessary to track down delinquent payments.
Improve Your Accounts Receivable Turnover Ratio with Carixa
When it comes to avoiding bad debt and managing your receivables turnover with confidence, manual processes can slow you down. Your teams — and your customers — deserve better.
Carixa software is more than just accounts receivable automation. It’s a solution that helps track and extract data, manage deduction recoveries, provide key insights and make improvements — all in one place. That means you’ll have more control over both credit and cash sales, helping improve your accounts receivable efficiency in ways that positively impact your entire customer base.
Ready to secure more working capital with a healthier cash flow and better customer, vendor and carrier relationships? Schedule a consultation with our team to see what Carixa software is capable of.