How accounts receivable turnover leads to longevity in business

A steady cashflow is the backbone of your company. It keeps operations running smoothly and positions you for bright prospects.

Every business owner dreams of this stability, and the key to making it happen lies in one essential metric: accounts receivable turnover.

Think of it as a mirror that reflects how well you receive customer payments.

When your collections are timely, you have enough funds to fuel expansion, thereby attracting investors to your business.

But what if your clients delay payments?

Unpaid invoices start piling up, making meeting operational demands challenging. 

No one wants that sinking feeling!

That’s why knowing your AR turnover can help determine if you’re afloat or drifting in the sea of credit management.

This comprehensive guide dives into how this metric works and why it’s a game-changer for your business. Let’s take a look!

What is accounts receivable turnover?

Accounts receivable turnover is a financial indicator that reveals how efficiently a company collects payments from its credit customers.

Also referred to as receivables turnover or debtors’ turnover, it measures how effectively you convert outstanding invoices into cash over a given period.

A high turnover indicates that you handle your accounts receivable (promises of payment from your customers, which, when they pay, turn into real cash) optimally.

This metric goes beyond waiting for money to come in; it depicts how well you manage and collect it. This further translates to more liquidity and less reliance on external financing.

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What is the significance of AR turnover? 5 reasons why you should monitor it

Navigating the international landscape with confidence requires a complete mastery of AR turnover. It ensures your revenue flows in as expected and helps fuel future endeavors.

Notably, many organizations today neglect this metric. 

The result? According to a Zippia study, about 22% of startups fail in their first year and 50% do so within the first 5 years.

Notably, their inability to manage their cashflow appropriately has led to the low survival rate down the line. 

Certainly, you don’t want to be a part of this statistic because your aim is to run a sustainable business. Let’s consider five reasons you should monitor your accounts receivable turnover.

1. It helps with cashflow management

Imagine running your company without the constant worry of overdue invoices hanging over your head — that’s the beauty of AR turnover.

With efficient cashflow handling, you can easily cover daily expenses, ensuring that you’re always prepared for future growth and unexpected events without financial strain.

On the other hand, late payments from clients can make it difficult for you to meet operational expenses or expand.

So, properly managing this metric will help you maintain liquidity, giving you the flexibility to adapt to new opportunities.

2. AR turnover evaluates credit policies

This metric is a great indicator of how effective your company’s policies are.

When your clients receive credit, the speed at which they settle their debts speaks volumes about your collection strategies.

If you boast a high yield, it means your payment terms are working well.

This allows you to focus on business growth. 

However, a low turnover implies there’s room for improvement. Perhaps your company takes too long to collect payments, or you’re offering credit to unreliable customers.

Regardless of the reason, this puts your business at unnecessary financial risk.

Thus, it’s beneficial to review your policies to enhance your turnover rate and, ultimately, your fiscal health. 

3. You get to understand your customer base better

Customers contribute to a business’s success. AR turnover provides valuable insights into the quality of your client base.

When it’s high, it indicates your clients are reliable and prompt in paying what they owe. It also shows your retention strategies are spot on. 

This kind of customer base is gold for any enterprise, as it ensures a consistent revenue stream and minimizes bad debts.

Conversely, the metric can indicate your user base may be filled with defaulters, which poses a threat to your financial stability over time. 

4. It enhances financial planning

Analyzing your AR turnover helps you better understand your payment trends and consumer behavior.

With this insight, you’re better prepared for whatever comes next. For instance, with a high rate, you can confidently pay off debts, reinvest in new projects, and plan for growth.

On the flip side, a low turnover is a wake-up call for tighter financial control. It may be the perfect time to reassess your credit policies or explore inventory management solutions to keep things running smoothly. 

5. It boosts your financial health

Ultimately, an effective collection process is an indicator of a company’s overall financial health and credibility.

It further signifies effective credit management and reliable revenue streams, which are crucial for sustaining success and building a solid financial foundation. 

As you monitor this benchmark, you can stay on top of your finances and ensure future growth and stability.

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Understanding the AR turnover ratio 

The accounts receivable turnover ratio measures how many times a company turns its debt into cash over a specific period, which can be a year, quarter, or month.

Think of it this way: when you sell on credit, you give your clients a short-term interest-free loan.

Now, the ratio reveals just how quickly these loans are paid back.

So, when the rate is high, you’re invariably saying, “Our collection processes are top-notch, and our customers pay up fast.”

Furthermore, this ratio is more than just figures; it’s a valuable tool for comparing businesses within the same industry. It assists investors to quickly see how well your company’s credit management practices stack up against its competitors. 

For instance, offering various payment options shows that you care about your clients.

Thus, buyers are spurred to pay their debts promptly, thereby increasing your AR turnover ratio.

Ultimately, this attracts investors to your company.

Notably, it’s important to watch out for misleading figures. Some businesses may inflate their turnover ratio by using total sales instead of net sales, which gives a false impression of their financial efficiency. 

Nonetheless, knowing how to calculate this rate will give you a clearer picture of your company’s cash flow and allow you to assess your credit management’s quality.

How to calculate the receivables turnover ratio

Calculating the accounts receivable turnover ratio is straightforward. Let’s break it down into three clear steps:

1. Get the net credit sales

The first step involves knowing the net credit sales. This is the total revenue earned via credit transactions, excluding cash sales. It’s calculated by subtracting any discounts or returns from gross credit sales.

Notably, it should be from a specific period, either monthly, quarterly, or annually. 

2. Calculate the average accounts receivable

Next, deduce the average accounts receivable.

To do this, simply add the beginning and ending accounts receivable balances for the same period used in calculating net credit sales and divide them by two.

3. Apply the formula

With these figures at hand, the accounts receivable turnover formula is straightforward: divide net credit sales by average accounts receivable.

Mathematically, Net credit salesAverage accounts receivable

The result will give you the AR turnover ratio, which indicates how many times a company collects its average receivables in the specified period.

Let’s walk through a practical example to better illustrate how to calculate it.

Imagine you own a tech company, XY, and offer credit sales to your clients.

Over the next year, your firm had gross credit sales amounting to $500,000. However, there were returns totaling $50,000.

Also, at the year’s start, the accounts receivable balance was $40,000; by year’s end, it became $50,000.

Let’s utilize the accounts receivable turnover formula:

First, calculate the net credit sales:

Net Credit Sales = Gross Credit Sales – Returns = $(500,000 – 50,000) = $450,000

Next, determine the average accounts receivable.

Average accounts receivable = {(Beginning accounts receivable) + (Ending accounts receivable)} /2

= (40,000 + 50,000)/2 = (90,000)/2 = $45,000

Then, calculate the accounts receivable turnover ratio

AR turnover ratio = Net credit sales / Average AR = 450,000/45,000 = 10

This means your company has collected its accounts receivables ten times during the year. It also reveals how efficiently you convert credit sales into cash.

Furthermore, you can calculate AR turnover in days. This will reveal the average number of days it takes customers to pay their invoices.

Using the same example, the receivable turnover in days = 365 days (1 year) / AR turnover ratio = 365/10 = 36.5 days

So, on average, it takes about 37 days for your clients to pay their debts.

Assuming you have a credit policy with payment terms of 30 days. In this case, our calculation reveals that your customers are paying later than expected. It then suggests tightening your policies or improving the collection process to ensure faster payment.

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What is a good accounts receivable turnover ratio?

A good accounts receivable turnover ratio means customers are paying on time, thus indicating stellar cashflow management.

This leads to a healthier balance sheet, efficient sales conversion, and enhanced creditworthiness. It’s like having a well-oiled machine that runs smoothly.

However, what’s considered “good” isn’t a one-size-fits-all answer, as it depends on the industry and business conditions.

Here’s a table showing the common averages in popular eCommerce industries according to CSImarket data.

While these ratios vary, hitting the right figure for your business requires fine-tuning your collection process, enforcing solid credit policies, and enhancing customer relationships.

These approaches can supercharge your revenue and boost overall financial performance.

How do you interpret accounts receivable turnover?

Here’s a simple way to interpret accounts receivable turnover:

High rate

Is a great sign. It means your company is doing a fantastic job receiving payments promptly.

This usually reflects a strong, reliable client base and an effective credit policy that avoids high-risk customers.

Low rate

Suggests delays in receiving payments. If customers take longer to pay it’s time to reassess your collection process.

Addressing these issues quickly can help prevent liquidity problems and keep your finances in check.

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Want to free up cashflow? Explore our cash ratio guide for more expert tips. 

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How to improve accounts receivable turnover: explore 5 key strategies

Improving your accounts receivable turnover involves building strong clientele, sending invoices promptly, embracing a proactive collection strategy, adopting automation, and offering early payment incentives.

By focusing on these strategies, you can turbocharge your business’ revenue. Let’s break them down further:

‍1. Building strong clientele

Building strong client relationships is the golden rule when it comes to managing accounts receivable.

Satisfied customers are far more likely to pay on time for the goods or services you provide.

Depending on the size of the business you run, maintaining these connections is key to smoother transactions.

So, cultivate simple interactions (like a phone call or a friendly mail) to remind your clients that they’re valued.

This positive rapport encourages timely payments and ensures customer loyalty and trust.

2. Manage credit wisely

Before extending credit to customers, assess their worthiness with a reliable scoring system.

Be dynamic in this approach by regularly reviewing and adjusting limits based on each client’s payment history.

This proactive approach ensures you’re not overexposing your business to defaults from buyers.

3. Send prompt invoices with clear terms

Being clear in your communication enhances timely payment.

Ensure your invoices clearly state due dates and offer various options to pay, such as checks, e-payments, or direct links in follow-up emails.

Additionally, send timely reminders to encourage clients to settle their accounts promptly.

4. Embrace automation

At its core, automation refers to using technology to perform tasks that were previously done manually.

This includes using sophisticated eCommerce tools to manage data entry, process payments, and keep records. 

A key area where automation is making strides is in cash application.

AI-powered software automates this process by matching incoming payments with outstanding invoices. This innovative feature streamlines operations, leading to a more efficient collection process and a good turnover ratio.

5. Offer incentives for early payments

You can offer early payment discounts to encourage your customers to pay faster.

This strategy leads to more prompt payments and also rewards loyal customers who are willing to pay upfront.

By offering attractive rebates for early payments, you foster stronger relationships with your clients and increase the likelihood of repeat purchases. 

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Stenn offers top-notch funding options to finance your business growth

There you have it!

Having explored the world of accounts receivable turnover, it’s clear that this metric is more than just a number. It’s a window into your company’s cashflow efficiency and financial health. 

A high ratio reflects an excellent collection process, precisely turning credit sales into cash.

As you maintain this rate, you set the stage for sustainable growth and long-term success.

Notably, navigating the nuances of credit management can be challenging.

However, you don’t need to fret. Stenn is a reliable financial ally with a proven track record of delivering billions of dollars in funding to diverse businesses. 

Our flexible solutions, including revenue-based and stock financing, are designed to meet your corporate needs and rewrite your cashflow story. 

So, when your customers delay payments, we’ve got you covered, ensuring your revenue never skips a beat.

Partner with us today and explore how our invoice financing solution can take your business to greater heights.