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Accounts Receivable Turnover Ratio - Formula, Calculation and Examples - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
of Wallstreetmojo
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friends today we are going to learn one
of the component of the ratio analysis
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that is the accounts receivable turnover
ratio which every entrepreneur is always
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concerned about that how the turnover of
account receivable is happening how what
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is the speed I mean what is a timeframe
so that's what they are always looking
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for let's understand the Formula the
receivables turnover ratio formula is
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something like this the net credit sales
absolutely you are analyzing that right
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divided by the average accounts
receivable so from the net credit sales
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what is the average account receivable
that is standing so let's understand
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what exactly are we talking about here
now account receivable turnover is
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basically another name of the turnover
ratio
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now in this ratio we will consider the
credit sales and the accounts receivable
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that's what we just saw now as you know
when a firm sells its goods on credit
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basis it takes a decent time to get paid
so the amount that the firm would
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receive due to the credit sells in near
future is called accounts receivable
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right now this ratio is a measure that the
that computes the proportion of how much
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the net credit sales a firm a firm has
and how much average account receivable
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firm is dealing with now let's have a
look at the formula the receivables
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turnover ratio RTO is equal to your net
credit sales divided by your average
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accounts receivable right so let's
understand with the with the help of an
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example so that you may have a clear
idea what we are trying to compute let's
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say there's a company called Gigs Inc.
and they have the following data like
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net credit sales the net credit sales
data let's say is $5 lakh they
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have some accounts receivable data as
$40,000 and they have this is basically
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the opening data
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and we have account receivable closing
CLG so that data is 60,000 now find out
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the account receivable formula over here
now in this above example we'll have all
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the information available first we will
find out the average account receivable
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so the average account receivable is
going to be your opening so I'll put
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this in a bracket we'll have the opening
plus we'll add the closing and then
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we'll divide by two which will give us
$50,000 so by using the formula of
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account receivable turnover we'll get
something like this
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the AR turnover ratio is equal to your
net credit sales right divided by the
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average account receivables so let's try
and put the numbers net credit sales is
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your 5 lakh divided by 50,000 which
will give us 10 times so if we compare
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the ratio with other company under the
similar industry we'll be able to
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interpret whether this number is
efficient or not so this is your ARTO
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that is your account receivable turnover
issue now let's try and understand a
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real-life example this was just a crude
example where you can exactly
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understand how the formula operates but
how about we take a a real-life example
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of a company Colgate let's calculate the
account receivable turn off all Colgate
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and you know we'll hear will be having
few assumption that all the sales will
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be or on credit basis okay for example
took the average or will take the
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average receivables at 2014 and 2015
data from this particular case the
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receivables turnover ratio or just just
check out the picture the sales divided by
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the average receivables data okay and
and over here as shown in the image took
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the average receivables we took the
average receivable of 2014 and 2015 this
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is the cash and cash equivalents and for
the sales data right so will be having
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couple of things or on over here
on an average the Colgate's account
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receivable turnover ratio has been
around 10x and the higher receivable
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turnover ratio implies that the higher
frequency of converting the receivables
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into cash which is of good thing it's absolutely a good thing because if
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you are able to convert your receivables
into cash quickly that means you have a
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high liquidity and that's that's good
for the company that's good for the
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pocket of the company right now this is
the receivable turnover data of Colgate
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as you can see from December 8 it has
just moved up 9.62 10.19x
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then it has move down move down to 10.22 but again
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it has taken a rise and it's rising and
it's rising so that's a good thing now
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we note that you know the PNG
receivables turnover ratio is is
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slightly higher than Colgate okay and
you know this is basically you know
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comparison of the receivable comparison
of the receivable turnover of Colgate
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versus the PNG data and you Neely was
receivable turnover ratio is close
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enough to with the Colgate numbers right
so now let's get back to our explanation
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on the account receivable turnover
formula now in the above ratio we have
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two components the first component is
the net the net credit sales and we need
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to keep in mind that here we cannot take
the total net credit sales we need to
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separate the cash sales and the credit
sales and that we need to deduct any
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sales return remember this thing very
sure that you know you did need to
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deduct any sales at unrelated to the
credit sales from the credit sales so
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you could so your sales is going to be
your credit sales minus any sales return
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then and then you will get a right
answer the second component is the
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average this is your first component
okay your your average accounts
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receivable right average accounts
receivable so to find out the average
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account receivable we need to consider two elements again the opening account
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receivable and the closing to find out
the average of the 2 now what is the
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use what is exactly the significance the
use of the account receivable formula
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see account receivable turnover is
basically an efficiency ratio and it it
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is used to see how many times the
account receivable have been seen
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collected during the fiscal year right now the third thing
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the higher the account receivable
turnover ratio is healthy as we have
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already discussed okay that's a healthy
for company and it denotes that the time
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interval between the credit sales and
the receipt of the cash okay is low and
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the math that and that means that the
form is quite efficient in collecting
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the account receivable on the other hand
a low a lower accounts receivable
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turnover ratio is not good or enough for
the company it indicates of the time
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interval between the credit sales and
the receipt of the money is higher and
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as a result there is always a risk of
not receiving the money that's called
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the bad debts right and when an investor
looks at the account receivable turnover
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he or she needs to know how efficient
okay how efficient the firm is in
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connecting the due amount if there is an
a risk in dealing or noticing the
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payment it may directly affect the cash
from the company now this is your
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account receivable turnover calculator
if you put numbers over here let's say
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your net credit sales is is 1 million
okay and your average accounts
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receivable which are standing in your
balance sheet is 5 lakh right so it's
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going to be half so you mean you are
saying that you know my net credit
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sales are 1 million but the amount
outstanding that I have to recover from
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the debtors is only $5 lakh so
what's going to be a receivable turnover
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ratio two times right so that's a good
that's a bad number you can say no you
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are only able to convert your net credit
sales only two times into cash
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now as this number is going to increase
let's say we are going to make it six lakh
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your data will go down that means
your receivable turnover ratio will go
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down so what interpretation we can make
as the account receivable goes down
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keeping the net credit sales as same
your receivable turnover goes down and
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that means it's not good but as this
amount decreases it will automatically
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increase and if we put 1 lakh tall
over here we'll get 10x as the number so
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put down your own numbers and try and
make an interpretation of the same thank
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you everyone for joining
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