Similar to the AR turnover ratio and DSO, CEI is an essential metric for tracking accounts receivable. If there’s an increase in bad debt, the company should reconsider its collections and credit policies. A simple formula to calculate the ratio is:īad Debt Ratio= (Uncollectible sales/Annual Sales) x 100 The bad debt ratio indicates the percentage of the bad debt affecting a company’s bottom line. Bad debt is the amount written off by a business when customers cannot pay the debt back. Businesses can obtain an overall picture of its collections process and its performance if they compare AR turnover ratio and DSO together.Ī high turnover ratio with low DSO means: a company has good collections and credit policy.Ī low turnover ratio with high DSO means: a company must optimize its collections and credit policy.Īnother important metric that AR managers should monitor is the Bad Debt to Sales Ratio. This shows, on average, a company has 36.5 days of outstanding receivables. If the AR turnover ratio is 10, then a simple formula to calculate DSO is: Another variant of receivable turnover is the DSO, which calculates the average number of days it takes for a company to collect receivables after a sale. AR turnover ratio of 10 implies that a company could collect its receivables 10 times in a specified period. To gauge how effective an AR team is, you can analyze DSO along with the AR Turnover Ratio. To understand a company’s financial health better, AR managers should analyze the accounts receivable turnover ratio along with a few other parameters. While this metric could state that a company’s credit policy might be too lax or conservative, it doesn’t elaborate the ‘why’ behind the numbers. The accounts receivable turnover ratio is an important metric - but it’s still hypothetical and leaves room for assumptions. It could also be due to lenient credit policies where the company is over-extending credit to customers with more risk of default. It indicates that customers are defaulting and the company needs to optimize collection processes. On the other hand, a restrictive credit policy might drive away potential customers or limit business growth, negatively impacting sales.Ī low accounts receivable turnover ratio or a decrease in accounts receivable turnover ratio suggests that a company lacks efficient collection strategies to collect receivables on time. A benefit of having a conservative credit policy is that businesses effectively avoid unnecessary loss of revenue by not extending credit to customers with poor credit history. It could also signify that a company has a pretty strict credit policy while offering sales on credit to its customers. High Accounts Receivable Turnover RatioĪn increase in accounts receivable turnover ratio indicates that a company is efficient in collecting cash and has promptly paying customers.A high or a low receivable turnover tells us how quickly or slowly a company collects its receivables. The accounts receivable turnover is used to analyze how effective a company's revenue collection is, and that's why it's important. We’ll understand this in depth in the following sections. But if the customers are paying back within the policy time, the ratio is high, thereby contributing to a good accounts receivable turnover.Ī good accounts receivable turnover means that a business has a solid credit policy, an excellent due collection process, and a record of exceptional customers who pay their dues on time. With a 30-day payment policy, if the customers take 46 days to pay back, the Accounts Receivable Turnover is low. For instance, let's talk about Company A's payment policy itself. What is a Good Accounts Receivable Turnover?Ī good accounts receivable turnover depends on how quickly a business recovers its dues or, in simple terms - how high or low the turnover ratio is. Now, if Company A has a strict 30-day payment policy, the accounts receivable turnover days show that on average, customers pay late. This means, an average customer takes nearly 46 days to repay the debt to company A. Receivable turnover in days = 365/AR turnover ratio Now, it is also crucial to calculate the accounts receivable turnover in days. = /įrom the above calculation, we can conclude that company A has successfully collected accounts receivable eight times in a year.
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