The sooner your business its paid for the products and services it provides to customers, the sooner you have money in the bank to pay your bills and invest in expansion. Accounts Receivable (AR) turnover is the rate at which your business collects on the invoices it issues, measured in terms of the number of times per year you collect the amount that is typically owed to you.
Calculating AR Turnover
To calculate your average rate of AR turnover, determine the average amount of your unpaid invoices throughout the year by first figuring out your credit sales for the year. Next, add your accounts receivable figure on the first day of the year with the sum from the last day of the year and divide that total by two to reach an average. Then, divide the total credit sales by the average of your customer credit balances. For example, if you extended terms to your customers for $200,000 over the course of the year, and the total owed was $30,000 on January 1 and $20,000 on December 31, then you divide $200,000 by $25,000 (the average of $30,000 and $20,000) for an AR turnover rate of eight.
An AR rate of eight indicates your receivables turned over eight times during the year or about once every 45 days (365 divided by 8).
Why AR Turnover Matters in Business
If your company is chronically short on cash, improving your AR turnover rate may be the key to solving the problem. You can improve AR turnover by creating tighter payment terms for customers, such as net 15 rather than net 30, or offering a small discount if they pay more quickly. You can also speed up your turnover rate by reminding customers more frequently of the amounts they owe you. These reminders can be as unobtrusive as a line on a current invoice listing the customer's previous balance. Alternatively, you can send emails, make phone calls or mail statements with information about the status of a customer's account. It can be unpleasant to issue these reminders, but it's worth the effort to be paid for work you have already performed according to payment terms that your customer knew when the transaction took place. If your cash flow is comfortable, you may opt for a more leisurely AR turnover rate because longer terms are appealing to some customers who may choose a vendor that allows more time to pay over one who requires quicker payment.
AR Turnover Ratio
Your AR turnover ratio is another way of framing the information provided by your AR turnover rate, but the rate and the ratio are two separate names for essentially the same piece of information. When expressed as a rate, this number means that on average you collect the amounts your customers owe you a certain number of times over the course of the year. When expressed as a ratio, it means that the total amount you were owed for the year was typically eight times the amount you were owed at any point during the year.