Accounts Receivable Turnover Ratio

Definition of Accounts Receivable Turnover Ratio

The term “accounts receivable turnover ratio” refers to the accounting measure used to check how effectively a company can collect its receivables generated due to credit sales over time. In other words, it is the efficiency ratio that gauges the ability of a company to manage the credit extended to its customers. A high ART Ratio is always good as it indicates that the company can collect the receivables quickly. On the other hand, a low ART Ratio indicates weak credit policies, which can be seen as a matter of concern.

Formula 

The formula for ART Ratio can be derived by dividing the credit sales during a period by the average accounts receivable. Mathematically, it is represented as,

The net credit sales include all of the sales over a period of time that were executed not on cash but on credit. However, if the company does not specify the quantum of credit sales, the entire sales are considered on credit as a thumb rule. The average accounts receivable is the accounts receivable average at the beginning of the year and at the end of the year.

Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable) / 2

Examples of Accounts Receivable Turnover Ratio (With Excel Template)

Let’s take an example to understand the calculation of the ART Ratio formula in a better manner.

Example – #1

Let us take the example of a company engaged in trading various wholesale grocery items in California. The following information is made available from the latest annual report:

Solution:

Average Accounts Receivable is calculated by using the formula given below

Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable)/2

• Average Accounts Receivable = ($80 million + $90 million) / 2
• Average Accounts Receivable = $85 million

Accounts Receivable Turnover Ratio is calculated by using the formula given below.

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

• ART Ratio = $250 million / $85 million
• ART Ratio = 2.94

Therefore, the company was able to collect its receivable 2.94 times during the year.

Example – #2

Let us take Apple Inc.’s example to illustrate the ART Ratio concept. The company reported net sales of $265,595 million for the year 2018. During the same period, the opening accounts receivable (net) and the closing accounts receivable (net) stood at $17,874 million and $23,186 million, respectively. Based on the given information, calculate the accounts receivable turnover ratio for Apple Inc. for the year 2018.

Solution:

Average Accounts Receivable is calculated by using the formula given below

Average Accounts Receivable = (Opening Accounts Receivable + Closing Accounts Receivable)/2

• Average Accounts Receivable = ($17,874 million + $23,186 million) / 2
• Average Accounts Receivable = $20,530 million

It is calculated by using the formula given below

Accounts Receivable Turnover Ratio = Net Sales / Average Accounts Receivable

• ART Ratio = $265,595 million / $20,530 million
• ART Ratio = 12.94

Therefore, Apple Inc. managed to collect its receivable 12.94 times during 2018.

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Example – #3

Now, let us take the example of Walmart Inc. in order to calculate the accounts receivable turnover ratio. According to its latest annual report (2018), the company booked net sales of $495,761 million, while the opening receivable (net) and the closing receivable (net) stood at $5,835 million and $5,614 million, respectively. Therefore, calculate the ratio of Walmart Inc. for the year 2018.

Solution:

Average Receivables is calculated by using the formula given below

Average Receivable = (Opening Receivable + Closing Receivable)/2

• Average Receivable = ($5,835 million + $5,614 million) / 2
• Average Receivable = $5,725 million

It is calculated by using the formula given below

Accounts Receivable Turnover Ratio = Net Sales / Average Receivable

• ART Ratio = $495,761 million / $5,724.5 million
• ART Ratio = 86.60

Therefore, Walmart Inc. collected its receivable 86.6 times during 2018, which is in line with its business which involves relatively low accounts receivable.

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Advantages and Disadvantages of ART Ratio

Below are some pros and cons of the ART ratio, which are as follows –

Advantages

• It can help in understanding the credit policy of a company and its bargaining power among its customers.
• It indicates the quality of customers that the company is dealing with.

Disadvantages

• In the case of seasonal businesses with a peak period in the middle of the year, the ratio may not reflect the true picture as the calculation is based on accounting figures at the start and at the end of the year.
• The use of entire sales in place credit sales results in an inflated ratio that fails to represent the actual collection management of a company.

Conclusion

So, the accounts receivable turnover ratio is a measure of how quickly a company is able to collect the receivable owed by its clients.

Recommended Articles

This is a guide to the Accounts Receivable Turnover Ratio. Here we have discussed the introduction, examples, advantages, and disadvantages of the ART ratio along with a downloadable excel template. You can also go through our other suggested articles to learn more –

1. Cash Ratio
2. Defensive Interval Ratio
3. Elasticity of Demand Example
4. Cash Flow From Operations Ratio