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Accounts Receivable (AR) Turnover Explained

Accounts receivable turnover or AR turnover is a ratio representing the number of times a business receives its average accounts receivable within a single year. This purpose of obtaining this ratio is to assess a company's efficiency in credit issuance and fund collections.

 

If this ratio is high, it indicates that the company is conservative in its credit policies but uncompromising in its collection efforts, and has many good customers. In an opposite scenario, a company is presented with an opportunity to boost its collection of longstanding receivables, which are unnecessarily restricting working capital. 

 

A low AR turnover could be caused by a number of factors, such as absent or lax credit policies, an inefficient collections department, and a significant number of customers experiencing financial hardship. It can also be considered as a sign of a company dealing with too much debt. Such factors are also better explained if you click here.

 

It is wise to monitor AR turnover on a trend line in order to detect a slowdown. When this happens, increasing collection funds may be needed, or at least, managers should sit down and take stock of the underlying factors. To compute for AR turnover, add the beginning and ending AR to get the average AR for the specific measurement period, and then divide this into the year's net credit sales.

 

There are companies that put total sales on the numerator instead of net credit sales. This, however, can lead to a wrong measurement if the cash sales proportion is high, with the amount of turnover looking higher than what it truly is.

 

An extremely high accounts receivable turnover ratio may be a sign of a too strict credit policy, in which a credit manager only approves credit for the most highly qualified few, giving competitors with laxer credit policies an advantage.

 

The beginning and ending AR balances are only for two particular instances within the measurement year, and the balances on such two dates can be dramatically different from the average amount for the whole year. Hence, another method of computing for the average AR balance, like the average ending balance of each month of the year, may be acceptable.

 

It is possible for the credit and collections department to have nothing to do with a low AR turnover.  That's because problems could also exist in other areas of the operations. For instance, for goods shipped with damages, customers will naturally refuse to make payment. Therefore, the factors leading to a poor measurement result could be distributed around many sections of the business. Get some bookkeeping ideas here: https://en.wikipedia.org/wiki/Template:Bookkeeping

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