And depending on your appetite for risk, this could vary significantly from business to business. The challenge with this method, however, is that under the Generally Accepted Accounting Principles (GAAP), an expense needs to be recorded in the same period as its corresponding revenue. This means you won’t be able to wait until you know for sure that a debt is uncollectible to write it off. If your number of revised invoices is high, it could point to broader invoicing problems—like frequent errors from manual data entry—that might only be resolved by introducing AR automation. Revising just one invoice can take substantial effort because your AR team must spend time investigating the cause of the dispute and evaluate whether you’ll provide a price reduction. In these cases, the seller might issue a credit memo for billing corrections, which documents the reduced amount the customer owes.

How to Put the Cash Conversion Cycle to Work for Your Business

Having a high turnover ratio doesn't necessarily mean everything is good though — this efficiency might be the result of a very conservative credit policy. A conservative credit policy means the company is perhaps overly selective about whom it extends credit to, possibly requiring stricter terms or quicker payments from customers. A higher ratio shows you're doing a better job at converting credit sales into cash. Your receivables turnover ratio can give insight into your AR whether your practices are leading to a healthier cash flow.

How to Increase Accounts Receivable Turnover

Skip the steps of the accounts receivable collection process by getting payments in cash. This way you save time from the AR process, and you get cash on hand immediately. To encourage cash payments, for example, you could offer a discount to customers who pay in cash. If the accounts receivable turnover is low, then the company’s collection processes likely need adjustments in order to fix delayed payment issues. The Accounts Receivable Turnover is a working capital ratio used to estimate the number of times per year a company collects cash payments owed from customers who had paid using credit.

Send invoices on time:

The turnover ratios indicate the efficiency or effectiveness of a company’s management. If you believe that your accounts receivable turnover ratio is too low and is negatively impacting your business, then you must take action to better your accounts receivable. While high ar turnover rates are beneficial, you should also be wary of them being too high.

Improving Accounts Receivable Turnover Ratios

  1. We can interpret the ratio to mean that Company A collected its receivables 11.76 times on average that year.
  2. By determining how satisfied your customers are with their billing and payment experience, you can see if there are areas where you need to make improvements.
  3. This efficiency is crucial for maintaining liquidity and ensuring the company has the funds to cover its obligations and ongoing operations.
  4. Ensuring a systematic and efficient collection process is key to keeping cash coming into your business — just as vital as making sales and providing your products or services.
  5. For businesses with seasonal sales or sales that fluctuate month-over-month, calculating your DSO over the course of a quarter instead of a month is a great way to normalize the data to see trends over time.

Let’s take another look at Company X. With a turnover ratio of 7.8, its average time to collect on an invoice is around 47 days. Ensuring it falls within the standards determined by your company’s credit policies can also help you maintain a healthy cash flow and preserve positive relationships with your clients. A lower ratio could indicate that your company is liberal with extending credit and/or inefficient at collections. Generally, the higher ratio indicates a more fiscally stable and responsible company, but you may decide a lower ratio is OK to capture sales ahead of competitors or keep customers in tough economic conditions. That indicates a short collection period and that you have an efficient and effective collection process. Ensuring a systematic and efficient collection process is key to keeping cash coming into your business — just as vital as making sales and providing your products or services.

Strategies to Improve Your AR Turnover Ratio

In effect, the amount of real cash on hand is reduced, meaning there is less cash available to the company for reinvesting into operations and spending on future growth. Net sales is everything left over after returns, sales on credit, and sales allowances are subtracted. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. The goal is to maintain a low DSO number because a low DSO reflects quicker cash collection. If you’re using QuickBooks, you can check out our guide on how to generate an income statement in QuickBooks Online in a few minutes.

That's because it may be due to an inadequate collection process, bad credit policies, or customers that are not financially viable or creditworthy. A low turnover ratio typically implies that the company should reassess its what is a joint cost definition meaning example credit policies to ensure the timely collection of its receivables. However, if a company with a low ratio improves its collection process, it might lead to an influx of cash from collecting on old credit or receivables.

Calculating an accounts receivable turnover ratio offers insight into how well a business handles the collection of its receivables. By using an AR turnover formula, businesses can determine the efficacy of how they extend credit and collect debts. The AR turnover formula is an important financial metric used to understand a business’s cash flow.

A high receivables turnover ratio might also indicate that a company operates on a cash basis. Once you've gathered these two figures, you can begin to calculate your accounts receivable turnover ratio. This is calculated by dividing the net credit sales amount by the average AR balance. The accounts receivable turnover is measured by a financial ratio predictably called the accounts receivable turnover ratio (also known as the debtors turnover ratio). In simple terms, a high account receivables ratio means that your business is doing well in payment collection, while a low ratio means you could improve some things. The impact of these strategies on a company’s financial performance is significant.

It can sometimes be seen in earnings management, where managers offer a very long credit policy to generate additional sales. Due to the time value of money principle, the longer a company takes to collect on its credit sales, the more money a company effectively loses, or the less valuable are the company’s sales. Therefore, a low or declining accounts receivable turnover ratio is considered detrimental to a company.