Definition: The accounts receivable turnover ratio is an efficiency ratio that measures how often receivables are collected during a period. It also calculates both the quality and liquidity of the customer account balances. In other words, A/R turnover shows how many times a company can collect its average total accounts receivable during an accounting period.
What Does Accounts Receivable Turnover Mean?
What is the definition of accounts receivable turnover? This ratio helps measure two main things. First, it shows how efficiently and effectively a company can sell on credit and collect from customers. Obviously credit sales don’t do a company a lot of good if it can’t collect the actual cash from the customers when payments are due. Receivables turnover shows how often and how easily the company can collect money from its customers’ credit sales.
Second, it implicitly shows the quality of the customers that the company allows to purchase on credit. A company with a low accounts receivable turnover ratio could indicate that the company is having a difficult time trying to collect the money from the customers. If the company is allowing non-creditworthy customers to purchase goods on credit, the true value of the accounts receivable on the balance sheet is misleading because this amount will never be fully collected. Customers will default and the company will have to write off some of its receivables.
Investors and creditors use this ratio to help identify the liquidity and true value of the total receivables. In other words, they want to estimate how much will actually be collected and when the collections will take place.
The accounts receivable turnover formula is calculated by dividing net sales for the period by average accounts receivable. Since most of the time businesses don’t calculate a running average receivables total, we tend to use the average for the period by adding the beginning and ending balances and dividing by two.
Summary Definition
Define Accounts Receivable Turnover: Receivables turnover means the amount of times a company collects its entire receivables account over the course of a year.
