In order to run a business smoothly and without cash issues, company management has to recover its receivables from sales made to customers. Most of the business sells its products and services to its customers on cash and credit terms. But, if we look out in practical life, the credit sales accounts for around 80 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} to 90 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} of the total sales.
In order to recover money from customers, company appoints recovery department. But, in order to properly check the performance of the recovery department, there should be some sort of tool. One of these tools is Accounts Receivable Turnover Ratio. It is also called Debtor Turnover Ratio.
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
Net Sales figure is taken from income statement/ profit and loss statement of a company. Any Sales Return and Allowances should be subtracted from the total sales to arrive at the net credit sales figure.
Net Credit Sales = Total Sales – Sales Return – Sales Allowances
Average Accounts Receivable can be calculated from the balance sheet of a company. Just add current year closing balance of Accounts Receivable with previous year closing balance of Accounts Receivable, and then divide the total by 2 to get the Average Accounts Receivable.
Average Accounts Receivables = (Accounts Receivable Closing Balance + Accounts Receivable Opening Balance) / 2
This ratio is used to calculate how many times a company recover the payment in a period from its credit sales. A higher ratio shows the company is very efficient in tracking its customers and recovering the payment. On the other hand, a low ratio means company is very inefficient in collecting its payments from customers which could jeopardize the company going concern assumption which is one of the fundamental concepts of accounting in the preparation of financial statements.
Accounts Receivable Turnover Ratio varies from industry to industry. So, before going to blame your recovery department, you must check your competitors A/Rec Turnover Ratio to fully understand the causes behind the scene.
Example:
Jagdesh & Co. net credit sales for the period ended 30 June 206 is $600,000. The balance sheet reveals Accounts Receivable balances are $45,000 and $52,000 on 30 June 2016 and 30 June 2015 respectively. Calculate Accounts Receivable Turnover Ratio.
Solution:
Average Accounts Receivable = (Opening Accounts Receivable balance + Closing Accounts Receivable balance)
Average Accounts Receivable = ( 45,000 + 52,000 ) / 2 = $48,500
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
Accounts Receivable Turnover Ratio = 600,000 / 48,500 = 12.37
Performance Appraisal Using Receivable Turnover Ratio
Zerosoft is engaged in the production of shoes for males and females and currently holds arond 18 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} market share. Currently, it is facing some working capital issues. That is why it has decided to pay attention to its recoveries from customers. The Cheif Executive believes that its customers are taking too much time to pay their bills. He called you as the Finance Manager of the company and asked you to advise him about the performance of the reco very team. You collected following information from the financial statements of Zerosoft and XereSoft. XereSoft is the main competitor of Zerosoft in the shoe manufacturing industry and is regarded as the producer of around 20 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} prodiucts available in the market.
| Zerosoft | XereSoft | |
| Accounts Receivable Opening balance | 45,666 | 53,576 |
| Accounts Receivable Closing balance | 51,763 | 48,984 |
| Sales revenue – Credit | 150,000 | 203,000 |
Required:
You are required to calculate Debtor’s turnover ratio.
Average Accounts Receivable
| Zerosoft | XereSoft | |
| Accounts Receivable Opening balance | 45,666 | 53,576 |
| Accounts Receivable Closing balance | 51,763 | 48,984 |
| Total | 97,429 | 102,560 |
| Average Accounts Receivables | 48,715 | 51,280 |
| A/Receivable Turnover Ratio = Credit Sales / Average Accounts Receivable | ||
| Zerosoft | XereSoft | |
| Zerosoft | 150,000/48,715 = 3.08 | 203,000/51,280 = 3.95 |
XereSoft is performing better than the Zerosoft in collecting its recoveries from customers to which it sells products on credit basis. So, chief executive has the right opinion regarding the performance of the recovery department. Zerosoft has to revise its credit terms, discount policies and maximum credit allowed to customer policies to ensure that its working capital can be improved.