Accounts Receivable Turnover (Days)

Accounts Receivable Turnover (Days) (Average Collection Period) – an activity ratio measuring how many days per year averagely needed by a company to collect its receivables. In other words, this indicator measures the efficiency of the firm's collaboration with clients, and it shows how long on average the company's clients pay their bills. The ratio reflects the payment history of the firm's clients.

Using this ratio the analyst can measure the accounts receivable management efficiency on a firm. For instance, if the company has set 15 days as a maximum term for consumer loans, the accounts receivable turnover must not exceed this value. For more precise estimation, the accounts receivable turnover values should be compared with main competitors. It is reasonable to choose similar-sized companies for such comparison, for example, those that possess similar amounts of assets. It is also important to analyze the dynamics of this ratio. Decreasing accounts receivable turnover trend witnesses the fact that the firm's clients divert financial resources of the company for a less period on average. It is difficult to make a categorical statement on whether this is good for an analyzed company or not - if consumer loans are an important part of the company's marketing strategy the accounts receivable will grow, but this will lead to an increase in the sales volume. To make a straightforward conclusion it is necessary to conduct the analysis of the accounts receivable quality, to measure the economic efficiency of the consumer loans policy (to compare the profit increase, caused by the implementation of the consumer loans policy, with the volume of interest paid on the borrowings used for financing the accounts receivable). 

The increase of the accounts receivable turnover (days) ratio may have following reasons: deterioration of the buyers' payment discipline; activation of providing consumer loans for goods and services; mistakes during the definition of credit policies, which led to the provision of loans to unreliable debtors, etc. Generally, the increase of the accounts receivable turnover (days) indicates the necessity of a more detailed research on the accounts receivable credit quality with its division by segments, according to the dates due (up to 30 days, 30 to 60 days, 60 to 90 days, etc.).

Normative values for the accounts receivable turnover (days) are highly dependable on the industry. Values range for different industries looks like below:

Source: Almanac of Business and Industrial Financial Ratios

Resolving the problems with the accounts receivable turnover exceeding the normative range:

To keep the accounts receivable turnover under control, it is necessary to develop and implement a complex strategy of the accounts receivable management. The elements of this strategy are the markup for the consumer loan, fees in case of overdue payments (and an algorithm of actions in case the payment is not received on time), splitting customers into groups and choosing those, with which the company is ready to work without the instant payment on delivery.

Formula(s):

Accounts Receivable Turnover (Days) = Average Gross Receivables ÷ (Net Sales ÷ 360)

Accounts Receivable Turnover (Days) = 360 ÷ Accounts Receivable Turnover (Times)

The average receivables computation options look as follows:

Average Receivables (the preferable calculation method) = Sum of the accounts receivable at the end of each working day ÷ Number of working days

Average Receivables (if only monthly data available) = Sum of the accounts receivable at the end of each month ÷ Number of months

Average Receivables (if only annual data available) = (Accounts receivable at the beginning of the year + Accounts receivable at the end of the year) ÷ 2

During the computation, the following should necessarily be taken into account:

1. Only accounts receivable formed by the company's clients for delivered goods and services should be included to the calculation process. Accounts receivable that do not refer to this category should be excluded from the computation.
2. The value of the indicator happens to be misleading, in case of the strong seasonality influence or if the company uses standard business year system (from January till December). In these cases, the value will most likely be undersized because the actual sales volume at the end of the year will be lower than the average sales volume during the year. Also, overdue accounts receivable of the low quality may be written off at the end of the year.
3. Very often, during the external analysis, it is problematic to find out the cause of the indicator increase or decrease without access to the internal data.

Example:

Accounts Receivable Turnover (Days) (Year 1) = 266 ÷ (3351 ÷ 360) = 28,5

Accounts Receivable Turnover (Days) (Year 2) = 325 ÷ (3854 ÷ 360) = 30,3

Accounts Receivable Turnover in year 1 was 28,5 days. It means that the company was able to collect its receivables averagely in 28,5 days that year. In year 2 this ratio increased, indicating that the company needed 30,3 days to collect its receivables.

Tools and software to calculate:

You can use our Financial Statement Analysis App to calculate ratio and generete conclusion automatically.

Conclusion:

Accounts Receivable Turnover (Days) demonstrates the debtors' influence on the financial condition of a company. The stable ratio indicates company's thoughtful policy of cooperation with its buyers and other debtors. A notable increase of the average collection period of a company comparing to the industry averages shows that its credit policy isn't reasonable and leads to the decrease of the firm's accounts receivable liquidity. At the same time, shortening the receivables turnover (days) much less than the industry competitors do would indicate the restrictive credit policy of a company and can lead to losing customers.