Frequently, enterprises are obligated to grant credit to their customers, allowing the latter to obtain the merchandise without promptly settling the accompanying invoices. It is incumbent upon the management of a corporation to ensure that any outstanding receivables are collected within the designated timeframe; failure to do so will result in a negative impact on the cash flow of the business.
The approach employed to assess the effectiveness with which receivables are collected and such debts are extended is referred to as the receivables turnover ratio. Asdicated by the receivables ratio, a business’s ability to manage these short-term credits is determined.
The accounts receivable turnover ratio is an alternative name for this efficacy metric, in addition to receivables turnover.
Formula in Mathematics Denoting the Receivables Turnover Ratio
Two key variables—average accounts receivable and net credit sales—are crucial in determining the receivables turnover ratio for a specific organization. This yields the formula for the receivables turnover ratio:
Receivables turnover ratio = average accounts receivable divided by net credit sales
The average accounts receivable can be calculated by adding the accounts receivable at the start and end of the given period and then dividing the result by two.
To illustrate, in order to calculate the receivables turnover ratio for the second quarter of a specific year, it is necessary to aggregate the tangible receivables at the beginning and end of this quarter prior to dividing the result by 2.
In a similar vein, net credit sales pertain to the revenue produced by credit-completed sales subsequent to the deduction of customer returns. Thus,
Customer returns minus gross credit sales equals net credit sales.
