The receivables turnover ratio measures how efficiently a company collects money from customers who purchased on credit. A high ratio indicates quick collection; a low ratio may signal collection problems or overly lenient credit terms. This guide explains how to calculate and interpret this important financial metric.
What is Receivables Turnover?
The receivables turnover ratio shows how many times a company collects its average accounts receivable during a period. It reveals how effectively the company converts credit sales into cash.
Key insight: Companies need cash to operate. The faster a company collects receivables, the sooner it can use that cash for operations, investments, or debt repayment.
Calculating Receivables Turnover
Basic Formula
Receivables Turnover = Net Credit Sales / Average Accounts Receivable
Finding the Inputs
- Net Credit Sales: Total revenue minus cash sales and sales returns (if not available, total revenue is used)
- Average Accounts Receivable: (Beginning AR + Ending AR) / 2
Calculation Example
Company XYZ's financial data:
- Net credit sales: $2,000,000
- Beginning accounts receivable: $150,000
- Ending accounts receivable: $250,000
- Average AR: ($150,000 + $250,000) / 2 = $200,000
Receivables Turnover = $2,000,000 / $200,000 = 10
The company collects its receivables 10 times per year.
Days Sales Outstanding (DSO)
Convert receivables turnover to days for easier interpretation:
DSO = 365 / Receivables Turnover
Using our example: 365 / 10 = 36.5 days
On average, customers pay their bills within 36.5 days.
Interpreting the Ratio
High Receivables Turnover
- Quick collection of receivables
- Efficient credit and collection policies
- Strong customer credit quality
- May indicate strict credit terms limiting sales
Low Receivables Turnover
- Slow collection of receivables
- Lenient credit policies
- Potential collection problems
- Cash flow challenges possible
Industry Benchmarks
Receivables turnover varies significantly by industry:
- Retail (cash business): Very high (20-50+) since most sales are cash or credit card
- Manufacturing: Moderate (8-12) with standard business credit terms
- Healthcare: Lower (6-10) due to insurance payment delays
- Government contractors: Lower (4-8) due to slow government payments
Context Matters
Always compare receivables turnover to industry peers. A ratio of 8 might be excellent in one industry and concerning in another. Do not compare ratios across different industries.
What Affects Receivables Turnover
Credit Policy
Strict credit terms (net 15) lead to faster collection than lenient terms (net 60). Tighter credit may reduce bad debts but could also reduce sales.
Customer Mix
Large corporate customers often negotiate longer payment terms. A shift in customer mix affects collection speed.
Collection Efforts
Active collection follow-up improves turnover. Companies with dedicated collections teams typically collect faster.
Economic Conditions
During recessions, customers may delay payments, reducing turnover. Monitor trends during economic cycles.
Red Flags to Watch
Declining Turnover
If turnover decreases over time, investigate:
- Are credit terms becoming too lenient?
- Are customers having financial difficulties?
- Is the collection process breaking down?
- Is the company booking questionable revenue?
Receivables Growing Faster Than Sales
If accounts receivable increase faster than revenue, collection efficiency is deteriorating. This can signal future cash flow problems.
Much Lower Than Peers
Significantly lower turnover than competitors suggests inefficiency or credit quality issues.
Using Receivables Turnover in Analysis
Cash Flow Analysis
Improving receivables turnover releases cash. Declining turnover ties up cash in receivables.
Working Capital Management
Combine with inventory and payables turnover to assess overall working capital efficiency.
Trend Analysis
Track the ratio over multiple periods. Consistent decline warrants investigation even if the absolute number seems acceptable.
Competitive Analysis
Compare to competitors to identify operational advantages or concerns.
Trend Analysis Example
Company ABC receivables turnover over 5 years:
- Year 1: 12.0 (30 days)
- Year 2: 11.5 (32 days)
- Year 3: 10.2 (36 days)
- Year 4: 9.0 (41 days)
- Year 5: 7.5 (49 days)
The steady decline suggests deteriorating collection efficiency. Further investigation is needed.
Limitations of the Ratio
- Seasonality: Year-end receivables may not reflect typical levels
- Credit vs. cash sales: Mix changes affect the ratio
- Aggressive revenue recognition: Can artificially inflate receivables
- One customer impact: A single large customer can skew results
Related Financial Ratios
Use receivables turnover alongside these metrics:
- Inventory turnover: How quickly inventory sells
- Payables turnover: How quickly the company pays suppliers
- Cash conversion cycle: Complete working capital efficiency
- Current ratio: Overall short-term liquidity
Analyze Financial Ratios
Pro Trader Dashboard helps you track and compare financial ratios across your portfolio holdings.
Summary
The receivables turnover ratio measures how efficiently a company collects money from credit customers. Calculate it by dividing net credit sales by average accounts receivable. Convert to days sales outstanding (DSO) for easier interpretation. Higher turnover indicates faster collection, but always compare to industry peers. Watch for declining trends and receivables growing faster than sales. Use this ratio alongside other working capital metrics for comprehensive analysis.
Learn more about financial analysis with our guides on inventory turnover and cash conversion cycle.