The accounts receivable turnover (AR turnover) is a measure of a company’s effectiveness in collecting payments from its clients and customers. It is calculated using the accounts receivable turnover ratio (AR turnover ratio) and the receivable turnover ratio formula with the values of net sales (net credit sales) and the average accounts receivable.
But once you calculate it, how can you know what is a good accounts receivable turnover? How can you assess your company’s performance from the activity ratio value?
In theory, a high turnover ratio is good, and a low turnover ratio is bad. However, in practice, not everything is that black and white.
Assuming you’re comparing your own business’s historical performance, or a similar competitor, a high account receivables ratio means that your business is doing well in payment collection, while a low ratio means you could improve some things. However, more is needed to determine if your accounts receivable turnover is “good.”
To truly understand the meaning of your company’s receivables turnover ratio, you need to understand how it fits with the overall performance and how you can effectively compare with other businesses.
High Receivable Turnover
A high turnover rate is characterized by a higher ratio, meaning that a company collects payments from its customers relatively quickly without a long waiting period.
A high-efficiency ratio could indicate:
- The company has high-quality customers who pay their debts in due time.
- The business likely has little to no trouble managing its cash flow and supporting its advancement.
Businesses that run on a cash basis (for example, grocery stores,) have incredibly high turnovers. That is why the receivable turnover ratio alone is not a good indicator of the efficiency of their credit policies.
Furthermore, a high turnover doesn’t have to be a good thing. It can also mean that a company is:
- Too aggressive with its debt collection
- Too strict with credit policies
- Losing customers to their competitors that have more favorable credit terms
Low Receivable Turnover
A low turnover means a low turnover ratio. Manufacturing companies tend to have a low accounts receivables turnover ratio because it takes them a relatively long time to manufacture a product, ship it to their customers, and receive payment.
In theory, a low receivable ratio is a sign of bad debt collecting methods, poor credit policies, or customers that are not creditworthy or financially viable. A company with a low turnover should reassess its collection processes to ensure that all the receivables are paid on time.
If your company’s turnover is low compared to your competitors, it might not be a reflection of your credit policies at all. Perhaps a different part of your business is lacking, like your distribution system. If it takes a long time for your product to reach your customers, that may lead to a longer-than-average time for them to pay.
How to Compare the Receivables Turnover Ratio
Comparing the ratios of two different businesses does not make much sense. If you put up an average grocery store against a car part manufacturer, you will get vastly different ratios that will likely lead you to the wrong conclusions.
For a fair assessment of the accounts receivable ratio, it is crucial to compare businesses with the same:
- Working capital structures
- Payment terms
- Within the same industry
Choose competitors that are roughly the same size and preferably have the same business models as your company. That way, you will get an accurate idea of your turnover ratio compared to the industry average.
It would be best to find the average receivable turnover for your sector and then evaluate where your company’s ratio stands in comparison to it.
How to Improve Your Receivables Turnover
If you find that your receivables turnover ratio is low compared to businesses similar to yours, there’s no reason to despair. There are practical ways to improve it.
Maintain Accurate and Regular Invoicing
Make sure that all of the invoices you send out are accurate and detailed. When everything is neatly laid out on paper, it will be much easier for your customers to understand what the bill says and what amount is required for them to pay.
If there is a set date for invoicing, don’t miss it. If there isn’t, send your bill the moment the work is completed or delivered. If you send in your invoices late, you risk setting a standard for late payments for your customers.
Furthermore, do not wait for the outstanding costs to pile up before you invoice a client. If more than a month passes between the finished work and the invoice, your customers have already mentally moved on. It is also more sensible for them to pay regular smaller bills than one large bill at the end of a quarter.
If your accounting department is small or overwhelmed, outsourcing your invoicing to a capable F&A partner is an efficient way to both ensure accurate invoicing and lowering the burden on your in-house staff.
Build Strong Customer Relationships
To maintain a high accounts receivables turnover, you need to have strong connections with your customers. Businesses of all sizes benefit from having good customer relationships because happy customers are happy to pay for your goods or services.
Check in with your most loyal consumers. Send them an email, give them a call, or possibly even offer them a discount or a special deal. They won’t risk damaging the relationship they have with your brand by not paying on time.
Set Clear Payment Terms
When it’s time to collect your payment, you cannot hope to enforce policies or agreements you never disclosed to your customer. Therefore, you must be clear about the payment terms of your company upfront. Ensure that all communication with your customer (agreements, contracts, and invoices) state what their duties are in terms of payment.
A common restriction is giving a 30-day deadline for the payment (from the moment you send out the invoice). Don’t hesitate to include charges for late payments if your customers go over the 30-day limit. If you sell a product or service for a higher dollar value, you can implement payment plans or set credit limits that will work for you and your customer.
Use Software Reminders
It’s impractical to have several different spreadsheets for invoices, outstanding payments, new orders or clients, and similar. For example, businesses that started using QuickBooks and Excel can quickly run into trouble as they scale.
Investing in a software solution like Consero’s Simpl platform keeps everything in one place. It will be easier for you to keep track of everything. You could also set up software reminders for yourself and for your customers that their payment is due.
You won’t have to worry about remembering whether you sent an invoice on time or whether the customer paid on time because your software solution will do everything for you.
Simplify the Billing Structure
A simpler billing structure can eliminate a lot of confusion and panic on the customer’s side. If it is at all possible for your business, try to switch to fixed-fee billing. This means that every month (or at agreed intervals), the customer pays a fixed price for your product or service. Fixed-free billing goes a long way in ensuring that you don’t get calls from customers wondering why their bill is higher than expected.
Additionally, with this billing structure, you could arrange to withdraw payments from your clients’ accounts every month automatically. You won’t have to send them an invoice and wait for them to pay, which should increase your receivable turnover rate.
Tracking Your Receivable Turnover
Just as you cannot infer much from the turnover value alone, you also cannot make predictions of your company’s profitability or efficiency if you don’t keep track of the turnover over time. It will help you forecast your future cash flow, plan for future investments, or even get a bank loan! Banks often use the account receivable as collateral when approving a loan.
When tracking your receivables turnover, search for patterns that emerge over time. They will clearly showcase how your credit policies are affecting your company’s performance in the long run.
Streamline Your AR Turnover with an Outsourcing Partner
If you find that your ratio is not up to par, you can turn to a finance and accounting expert like Consero to improve it. Our proven Finance as a Service (FaaS) model provides the systems, processes, and people to quickly automate your AR process and ensure that your invoicing practices are impeccable with our AI-enabled solution.
We have the expertise to work within your existing system and general ledger. Through Consero’s FlexFinance service, we can manage the back-office F&A function from end-to-end process, including closing the books.
If you need skilled talent to manage your AR, we can supplement your F&A team via our FlexResources.
Reach out to us if you’d like some help with your receivables management and improving your account receivable ratio.
