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How to Calculate Your Accounts Receivable Turnover Ratio: Formula and Examples - YouTube
Channel: Fundera by NerdWallet
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In today's video, I'm going to explain how
accounts receivable turnover ratio works,
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including the formula, an example calculation,
and how to improve your turnover ratio.
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I'm Priyanka Prakash, small business expert
and senior staff writer at Fundera.
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Accounts receivable turnover ratio basically
tells you how good a job your business does
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at collecting on invoices.
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Many small business owners, especially B2B
businesses, bill their customers using invoices.
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Customers normally get a specific period of
time 30, 60, or 90 days to pay those invoices.
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The faster customers pay you, the better it
is for your business's cash flow and financial
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health.
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Let's dive right into the accounts receivable
turnover ratio formula.
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Accounts receivable turnover ratio equals
your net credit sales divided by your average
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accounts receivable. in this formula, net
credit sales means the portion of your annual
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sales that are tied up in invoices.
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Instead of receiving immediate payment for
the sales, you extend credit to your customers
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for these sales.
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To get net credit sales, you take your gross
sales and subtract cash sales, customer returns,
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and other allowances for customers such as
price changes.
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Average accounts receivable refers to the
average amount of money that customers owe
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to you throughout the year.
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To get this number, you can take the dollar
amount of accounts receivable that you had
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at the opening of the year, and add the dollar
amount of accounts receivable that you had
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at the end of the year.
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Then, divide this sum by two to get the average
accounts receivable.
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Now, accounts receivables are considered assets,
so you can find all the numbers that you need
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for this formula on your business's balance
sheet.
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Let's go through an example to better understand
how accounts receivable turnover ratio works.
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Here's a balance sheet for a fictional business,
ABC Bakery, that shows the start-of-year assets
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and liabilities and end-of-year assets and
liabilities.
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To calculate the accounts receivable turnover
ratio, I only care about the accounts receivable
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row on the balance sheet.
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In this case, ABC Bakery started the year
with $15,000 in accounts receivable and ended
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the year with more money—$30,000—in accounts
receivable.
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This shift can happen if your company has
an uptick in sales as the year is ending.
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Let's assume that ABC Bakery also had $100,000
in net credit sales for the full year.
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To calculate the accounts receivable turnover
ratio for ABC bakery, first calculate the
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average accounts receivable.
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Add up the opening year accounts receivable—$15,000—and
the end of year accounts receivable—$30,000—and
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divide by two to get the average accounts
receivable—$22,500 in this case.
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Next, plug your numbers into the accounts
receivable turnover ratio formula.
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Take the net credit sales of 100,000, and
divide by the average accounts receivable—$22,500—to
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get 4.44.
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This number means that ABC Bakery’s accounts
receivable turned over 4.44 times in the past
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one year.
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If you take the 365 days in a year and divide
by this accounts receivable turnover ratio,
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you get 82.
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That means it took on average 82 days for
ABC Bakery to collect on each invoice.
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So what makes a good accounts receivable turnover
ratio?
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Ideally, your business shouldn't take longer
than 30 days on average to collect on each
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invoice.
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The ideal amount of time of course could differ
based on industry and the stage of your business's
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growth.
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But in general, a higher accounts receivable
turnover ratio is usually better than a low
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ratio.
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A business with a high accounts receivable
turnover ratio tends to have stricter credit
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policies and is more efficient at credit collection.
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If you have a low accounts receivable turnover
ratio, it usually means that your credit policies
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are not strict enough or that you're having
issues with the debt collection.
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Less commonly, a low accounts receivable turnover
ratio could mean that there was a problem
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with a particular shipment of goods that led
more of your customers to refuse payment,
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so don't necessarily blame your credit collection
staff for a low turnover ratio.
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Now, the best way to improve your accounts
receivable turnover ratio is to have and follow
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sound credit collection policies.
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Basically, your goal is to get clients to
pay you as soon as possible.
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These are a few tips to encourage your customers
to pay invoices more quickly: Send your invoice
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immediately after a job is complete; Give
clients online payment options to reduce the
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friction of payment; Offer clients early payment
discounts and charge late fees so clients
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feel pressure to pay you faster; Ask for deposits
upfront: Send periodic friendly payment reminders
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to your clients; And don't work with habitually
late paying clients.
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For more advice on how to improve your accounts
receivable turnover ratio, also check out
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our video about unpaid invoices.
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In that video, we cover several strategies
to collect on debts more quickly.
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After watching this video, you should now
know how to calculate your accounts receivable
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turnover ratio.
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This ratio gives you a good look at an important
part of your business’s cash flow.
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It's a good idea to check your accounts receivable
turnover ratio at least once per quarter,
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maybe even more often, so you can take steps
to improve credit collection if there's a
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decline in your ratio.
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For more small business finance tips, visit
fundera.com.
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You can also go to
youtube.com/fundera loans, and subscribe to
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our channel for more videos.
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Feel free to ask questions and leave comments
below.
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We're happy to help!
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