The Debt Turnover Ratio

The debt turnover ratio, also known as the receivable turnover ratio, is an evaluation of how efficiently your business collects payments on account. The initial formula for debt turnover is annual credit sales divided by the average accounts receivable balance during the year.

Assume your business sells $2 million worth of supplies on account in a given year. The average accounts receivable is then computed by adding the beginning and ending balances, and dividing by two. If the beginning receivable balance was $200,000 and the ending balance was $300,000, the average was $250,000 when you divide the total by two. Therefore, your debt turnover for the year was $2 million divided by $250,000, which equals 8.0. This ratio means you turned over your debt eight times during the year.

It is also helpful to convert debt turnover to days to figure out how quickly your debts are paid. To do so, divide 365 days by the turnover rate of 8.0. The result is 45.63. You turn over your debt once every 45.63 days. Typically, you want your turnover ratio to fall well short of your typical payment terms with borrowers. If you allow 60 days for payment, for instance, 45.63 days is a reasonable turnover rate. However, if your payable turnover ratio is 41 days, you pay your debts more quickly than you collect payments. This scenario isn't favorable for your cash position.