Does your business allow customers to pay after the delivery or completion of their purchased products or services? Many businesses allow their customers to make purchases on credit. In other words, they don’t require payment upfront. Customers can purchase goods or services from these businesses while paying them at a later date. When doing so, however, you should consider tracking your business’s accounts receivable turnover ratio. What is accounts receivable turnover ratio exactly, and why is it important?
The Basics of Accounts Receivable Turnover Ratio
Accounts receivable turnover ratio is a measurement of your business’s cash flow. It takes into account your business’s credit-based sales — products or services purchased by customers on credit — as well as your business’s average accounts receivable. Using this information, you can gain a better understanding of your business’s overall cash flow.
How to Calculate Accounts Receivable Turnover Ratio
To calculate your business’s accounts receivable turnover ratio, take your business’s total credit-based sales for a fiscal period and divide that number by your business’s average accounts receivable. Average accounts receivable is the beginning balance and the ending balance divided by two. The purpose of using average accounts receivable is to see how quickly and effectively your business is able to collect money owed from its customers.
Why You Should Track Accounts Receivable Turnover Ratio
Invoices are a common element of accounts receivable. If you allow a customer to purchase a product or service on credit, you’ll typically need to send him or her an invoice. These outstanding and unpaid invoices are factored into your business’s accounts receivable. The longer it takes you to collect money from a customer, the higher your business’s accounts receivable will be.
Tracking your business’s accounts receivable turnover ratio, though, allows you to see how quickly and effectively your business is able to collect money from customers. More importantly perhaps, tracking your business’s accounts receivable turnover ratio will ultimately provide insight into its cash flow.
Not all businesses need to track their accounts receivable turnover ratio. Rather, only those that allow customers to buy products or services on credit can benefit from tracking this metric. Accounts receivable turnover ratio looks at a business’s ability to collect money owed by its customers versus the total amount of sales processed on credit.
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