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The account receivables turnover ratio, also known as debtors turnover ratio, is probably more difficult to say that it is to understand, despite its daunting, tongue-twisting terminology!
In the simplest of terms, the accounts receivable turnover ratio is the rate at which a business recoups its money on net credit extended – or, how effective it is in collecting its debts. This is not only applicable to financial companies but to every business that extends credit. The accounts receivable turnover ratio does not include cash sales, as they do not create receivables. It is best to look for short term financing options.
The company’s ability to turn intangible assets (in this case, net credit debts) into cold, hard cash-on-hand. Unfortunately, it is never a complete picture of a company’s finances, even when credit constitutes the majority of sales. It is merely a general assessment of liquidity based on accounts receivable from net credit already extended.
To determine a business’ ARR, divide the net credit sales by the average accounts receivable over the tracking period:
ARR = Net Credit Sales / Accounts Receivable (over the time period being tracked)
So, if your net credit sales are $10,000 and your accounts receivable is $2,000, your ARR would be 5. This may be high or low, depending on how often you collect on debts. For instance, if you collect monthly, this is low; if you collect quarterly, it is slightly higher than expected.
Technically speaking, a high ARR indicates a healthy collections process, trustworthy clientele, and/or a primarily cash-based business model. Again, cash sales are not part of the equation.
Extremes in either direction indicate that your collections model needs to be examined and probably modified. In the example above, an ARR of 5 for a business which collects monthly is alarmingly bad and probably, but not necessarily, indicates lenient or lackadaisical collections efforts. While the same ARR for a business which collects quarterly indicates a healthier debt collection process, it also suggests more aggressive collections efforts as it is slightly higher than expected.
Slow collections usually result in a low receivables turnover ratio. If your collections are slow, your cash flow could suffer, leading to problems with operating costs like payroll, utility, and inventory, and even repaying credit extended to you.
However, if your collections are too aggressive, your customer growth and retention could be threatened. If this is the case, the problem is compounded by driving customers to your competition. These issues are suggested by an ARR which is higher than expected. Do check out Small business loan by lending valley option.
The target accounts receivable turnover ratio depends on the period being tracked and how often the business collects on its debts. In general, this is between 30 and 90 days, though some companies may take up to six months or longer to collect on their debts.
Dissimilar companies and business models should not be compared. In fact, even when comparing businesses of the same type – say, two supermarkets or a string of pawn shops – the target ARR might not be the same for each.
It should only be used as a general overview, as the number of variables and the span of their variances is simply too great to exhibit an accurate assessment of a company’s collections process or liquidity. These variables include the amount of net credit extended, the amount of time in which these debts are collected, differences in customer payments, and past ARR scores. We also offer services for people having to bad credit business loans.
Like any mean statistic, extremes within the factors can evince misleading results. For example, a single outstanding debt worth several thousands of dollars could be a major factor in a low ARR. Such skewed results certainly deserve attention but should not result in a sweeping change in practice.
All that said, the Accounts Receivable Turnover Ratio is good for determining some things that can help a business owner improve efficiency and strengthen the company’s lending policies. A low account receivables score suggests examining the timeliness and efficiency of debt collections, the effectiveness of the business’ current collecting practices, and even customer satisfaction.
Other recommendations include reviewing the amount of credit you extend, the length of time in which the debt is expected to be repaid, the financial well-being of your debtors, and the strength of your cash sales. Something as small as an increase in advertising to attract new clients could solve the problem. Also, keep a check on the short term loan.
More complex or advanced issues might demand more severe responses, such as improving customer relations, implementing more competitive credit sales practices, changing debt collection processes, or upscaling your customer base. Keep in mind that it is three times harder to attract new clients than it is to retain one.
In other words, it might be a good thing to have a single debtor skewing your accounts receivable turnover ratio, as long as that account remains in good standing. A return customer with a strong payment history and large amount of debt with your business indicates a loyal customer.
Still, it might be a good idea to review the amount of credit being extended and the time in which it is being repaid. Your account receivables turnover can be a deceptively simple ratio unique to your business, but a higher ARR is preferred. Low ARR scores tend to mean a lack of cash flow which can lead to serious problems, including bankruptcy.
Even if your business model primarily operates on a cash basis, it is worth it to periodically check your accounts receivable ratio for a more replete assessment of your financial standing. If you do not extend credit then you have no accounts receivable, so ARR does not apply. Get in touch with us for any assistance related to short term financing.
A low ARR usually points to a (potential) liquidity issue caused by problems with the amount of credit being extended, collections practices, or a lack of cash sales. An ARR that is too high could mean you are not extending enough credit to attract and retain customers. You will get the best deals at the Lending Valley.
