The accounts receivable turnover ratio is a figure that is calculated to measure how effectively the business converts outstanding debt from customers into completed payments.
Accounts receivable refers to outstanding short-term debt or payments.
The turnover ratio represents the average value of accounts receivable for an accounting period in proportion to the total number of credit sales for the same period.
A high accounts receivable turnover ratio is a positive sign for the business, while a low ratio is a poor sign. A high turnover ratio indicates that the business has a high percentage of customers who are converting their outstanding debt into payments.
That is, they are paying their bills in a timely manner. This indicates that the business is doing a good job collecting payments from customers. Conversely, a low turnover ratio reveals that the business is doing a poor job of collecting payments.
There are two steps to calculate the accounts receivable turnover ratio, which is calculated as a fraction.
Add the balance for accounts receivable at the beginning of the reporting period to the balance at the end and divide by 2. This produces the average value of accounts receivable for the period.
Create the fraction (ratio). The calculation starts with the total value of sales on credit for the accounting period (cash sales are completed at the time of the transaction; they do not generate outstanding payments/accounts receivable and are not included in this total). This figure is divided by the average value of accounts receivable that was calculated in the first step.
Because the credit sales figure is the nominator in this equation, a larger average figure for accounts receivable will generate a lower fraction or ratio. If the average accounts receivable denominator is a small figure, it will generate a larger number.
Remember also that a larger number is a good sign for the business, while a smaller number is a bad sign. This is because a high turnover ratio means the business is converting a higher proportion of its credit sales into cash, and a lower turnover ratio means it is converting a smaller percentage of its credit sales into cash.