Special Offer for Chartered Accountant

black-logo
black-logo
Tally Automation
Jul 2, 2024

How to Determine the Turnover Ratio for Accounts Receivable

s_av
Pooja Lodariya

CA

linkedinfacebookinstagramyoutubetwitter
s_blog-post

Ever wonder how fast your company collects money from customers?

The Accounts Receivable Turnover Ratio (ARTR) can tell you exactly that.

Think of it as a scorecard for your collection efficiency. In India, following the Indian Accounting Standards (Ind AS), this ratio helps you understand how quickly customers settle their credit purchases. The higher the ARTR, the faster you collect payments, leading to better cash flow and less risk of bad debts.

ARTR is also a great tool for creditors to see if you can repay your debts on time. So, a healthy ARTR is important for your business and financial partners. Let's dive deeper and see how to make the most of it!

Understanding a Good ARTR

There's no magic number for a "good" ARTR. It depends on the industry you're in. For example, a grocery store might have a higher ARTR than a manufacturing company because customers typically pay for groceries right away.

That being said, a score of 7.8 or above is generally considered good. But here's the key: Don't compare yourself to this generic benchmark. The real trick is to see how your ARTR stacks up against your industry average and what your competitors are doing.

In India, there aren't specific rules for what a good ARTR is. However, Indian accounting principles (GAAP) recommend using industry benchmarks when evaluating financial ratios like ARTR. This gives you a more accurate picture of your collection efficiency compared to similar businesses.

Calculating the ARTR

Now that you know a good ARTR is industry-specific, let's unlock the formula to calculate your own. It's quite simple!

Here's the magic equation:

ARTR = Net Credit Sales / Average Accounts Receivable

Let's break it down:

  • Net Credit Sales: This is the total amount of money you earn from selling products or services on credit during a specific period (like a month or a year). Remember, this doesn't include cash sales or any returns or allowances given to customers.

  • Average Accounts Receivable: This represents the average amount of money customers owe you at any given time within that same period. To find this, add the starting balance of your accounts receivable at the beginning of the period to the ending balance at the period's end, and then divide that sum by two.

Example:

Imagine you run a clothing boutique. Here's what your calculation might look like:

  • Net Credit Sales: ₹100,000 (This is your total credit sales for a particular month, excluding cash sales and returns)
  • Beginning Accounts Receivable: ₹20,000 (This is the amount customers owed you at the beginning of the month)
  • Ending Accounts Receivable: ₹30,000 (This is the amount customers owed you at the end of the month)

Average Accounts Receivable: (₹20,000 + ₹30,000) / 2 = ₹25,000

Now, plug these values into the formula:

ARTR = ₹100,000 / ₹25,000 = 4

In this example, your ARTR is 4. This means that, on average, it takes you 4 times during the period (month in this case) to sell your products on credit and collect the payment from your customers.

Remember, a higher ARTR generally indicates faster collection. But as we discussed earlier, analyze this number in the context of your industry and competitor benchmarks.

Level Up Your ARTR: Simple Strategies for Faster Collections

We all know the importance of keeping clear financial records. Without them, our financial calculations become unreliable, leading to potentially misleading forecasts and reports. So, the first step to improving your ARTR is to enhance your invoice management.

Ditch the spreadsheets! Upgrading to accounting software ensures timely and accurate invoices go out the door every time. These tools automatically track your income and spending, providing reports that make it easy to spot areas for improvement. Plus, you eliminate human error, leading to more reliable financial data.

Effective credit policies are another key to success. These policies establish clear guidelines for how you extend credit, including:

  • Timeframes: How long do customers have to pay (e.g., 30, 60, or 90 days)?
  • Payment Terms: How, when, and where do you accept payments?
  • Default Policy: What happens if a customer doesn't pay on time (e.g., late fees)?
  • Collections Policy: How will you collect past-due accounts?

Clear policies ensure everyone's on the same page, from your sales team accepting payments to your accounting team managing the books.

Speaking of managing the books, ditch the pen and paper! Today's accounting software automates tasks like invoicing, policy enforcement, and sending payment reminders. The best solutions even use AI to analyze large amounts of data and pinpoint opportunities to optimize your invoicing and collections process.

Building stronger customer relationships can also improve your ARTR. When customers have a positive experience with your business, they're more likely to pay their bills on time. Here are a few ways to build those relationships:

  • Thank you messages: Show appreciation for new customers and solidify the connection.
  • Customer feedback: Ask how you can improve and show you value their input.
  • Loyalty programs: Reward repeat customers and encourage continued business.
  • Personalized touches: Birthday or holiday greetings demonstrate you care about your customers as individuals.

Not all customers are created equal. Assessing customer creditworthiness before extending credit helps you minimize risk. If a customer has a history of late payments, it might be best to require cash upfront.

Adjusting credit terms based on risk is another option. Customers with strong credit scores might qualify for longer payment terms, while those with lower scores might require a higher upfront payment. This protects you in case of non-payment.

Streamlining dispute management also impacts your ARTR. A slow process can lead to delayed payments. Create a clear system for addressing customer disputes quickly and efficiently. This could involve setting time limits for resolution and empowering employees to offer partial refunds when necessary.

Proactive follow-up on overdue accounts is essential. Develop a plan for reaching out to customers as soon as a payment is late. Regular reminders can motivate them to settle their outstanding balances.

Educating your team on ARTR best practices empowers them to contribute to efficient collections. Keep them updated on your policies, procedures, and best practices to ensure everyone's on the same page.

Collaboration is key! When creating ARTR policies and practices, involve your entire team. Their perspectives and fresh ideas can lead to innovative solutions and improved processes. Employees who feel heard are also more likely to be engaged and productive.

Also Read: Using Financial Ratios to Identify Strong Indian Businesses

Finally, conducting regular accounts receivable audits keeps everything on track. These audits ensure everyone's following policies and procedures, and they provide valuable data for future optimization. By regularly reviewing your accounts receivable process, you can continually improve your ARTR and keep your cash flowing smoothly.

Optimize Financial Well-Being Through Efficient Receivables Handling

There is considerably more to your accounts receivable turnover ratio than just a single figure. It serves as the foundation for financial projections for the future and demonstrates to you and your team how successful you are at converting provided credit into income.

Your company's turnover ratio for accounts receivable is a wonderful place to start if you want to strengthen its financial position. Make your accounts receivable department as effective as possible by using the preceding advice.

Recent Blogs

blog-img-Power of ICAI CA GPT - Empowering Chartered Accountants with AI
Power of ICAI CA GPT - Empowering Chartered Accountants with AI
s_av
Pooja Lodariya

CA

blog-img-Month-over-Month Growth: Your Quick Guide to Short-Term Success
Month-over-Month Growth: Your Quick Guide to Short-Term Success
s_av
Nishtha Arora

Suvit

blog-img-Net Revenue Retention (NRR): Your Secret Weapon for Business Growth
Net Revenue Retention (NRR): Your Secret Weapon for Business Growth
s_av
Divyesh Gamit

Suvit