How to improve accounts receivable turnover ratio
Keeping a company going by streamlining cash flow and liberating working capital requires a predictable and efficient accounts receivable (AR) process. Without it, you are stuck waiting for payments that never seem to arrive when you expect them. In order to determine how effective your existing accounts receivable processes are, you can calculate and monitor your AR turnover ratio. With this information, you will understand the common formula for calculating your company’s ratio, the impact of a high or low ratio, and how to improve accounts receivable turnover.
What is accounts receivable turnover ratio?
The accounts receivable turnover ratio provides a numerical assessment of your company’s ability to collect payment in a timely manner. The calculation is done by comparing the net credit sales from a particular period and dividing it by the average amount of funds in accounts receivable that the company has during the same period.
AR turnover ratio formula
Accounts Receivable Turnover Ratio = Net Credit Sales/Average Accounts Receivable
The formula has a couple of components you will need to determine your company’s ratio. To calculate the net credit sales, total all sales made on credit in the given period, minus discounts and returns. It is important to count only sales made on credit, as cash sales can skew the result. To get your average accounts receivable amount, add the account balance at the beginning to the amount at the end, and divide by two.
Accounts receivable turnover example
Company Z has $15 million in sales for the first quarter of the year, and $9 million of it counts as net credit sales. During the same period, the accounts receivable balance starts at $1 million and ends at $2 million, giving an average of $1.5 million. Using the accounts receivable turnover formula, Company Z’s AR turnover ratio is 6.
$9 million / $1.5 million = 6
To get a turnover rate measured by a number of days, you can divide the number of days by the ratio. In Company Z’s case, 90 days in the first quarter divided by 6 is 15 days. This means that Company Z’s average turnover rate in the first quarter is 15 days.
What is a good accounts receivable turnover ratio?
A high ratio indicates that your company is collecting payment regularly and quickly, while a low ratio shows a slower payment cycle. The ideal turnover ratio depends on a variety of factors, including industry standards and efficient processes to collect payment. Industries that are dependent on frequent sales and payment at the point of purchase may have a much higher ratio than industries that bill on a net 90 schedule and handle nearly everything on credit.
High accounts receivable turnover
Companies with a high accounts receivable turnover usually have one or more of these factors:
- Strict requirements for credit approval
- Structured invoicing and payment processing
- Incentivized payment schedules
If you are working on improving accounts receivable processing, tracking your ratio over time can be a helpful metric.
Low accounts receivable turnover
By comparison, businesses with a low accounts receivable turnover may struggle with the following problems:
- Lenient approval of credit to borrowers who are likely to default
- Lax collection processing
- Unclear or unenforced payment terms
For companies with a low turnover, comparing the turnover rate to the payment terms can be a helpful place to start. If you bill on a net 30 schedule and your turnover rate is 45 days, it means that your customers are often paying late.
Ways to improve accounts receivable collections
Whether you have a high or low ratio, you can probably find ways to cut down on unnecessary waste and make your processes more efficient. Here are eleven ways to improve accounts receivable collections.
1. Maintain positive client relationships
It is often the case that customers prioritize paying companies that they enjoy working with, or that are critical to their operations. Maintaining positive client relationships can increase future sales, but can also encourage prompt payment or improved payment terms.
2. Evaluate the creditworthiness of clients
Before extending credit to your clients, it is essential to evaluate their creditworthiness. You can do this by performing credit checks, reviewing financial statements, and assessing payment history with other vendors. By granting credit only to clients with a proven record of timely payments, you can minimize the risk of overdue accounts and improve your accounts receivable turnover ratio.
3. Enhance invoicing operations
In many cases, your clients cannot pay until they have an invoice. Using invoice management software can automate the process so that invoices are sent seamlessly on a schedule that works with your goals to improve your turnover ratio. It also frees up your AR employees to address issues that require human attention.
4. Set payment terms
If payment terms are unclear or applied inconsistently, it is not uncommon to face late or irregular payments. Clearly establishing payment terms at the contract stage, or updating and confirming terms with your regular clients, can lead to more consistent and predictable payments.
Many businesses set payment terms on industry conventions. It is worth factoring in your accounts payable ratio, to confirm that you are getting paid with enough time to handle your debts.
5. Simplify the process internally and for clients
Receiving payment from clients ought to be as simple as possible. If the accounts receivables process is easy to start and effortless to reconcile, you can improve your accounts receivable turnover. Streamlining the process saves time for your employees and your clients, which can lead to faster repayment.
6. Offer multiple payment options
Providing your clients with multiple payment options can make it easier for them to settle their invoices on time. Consider offering various payment methods, such as credit cards, bank transfers, online payment platforms, and even mobile payment solutions. By accommodating your clients’ preferred payment methods, you can improve the likelihood of timely payments and increase your accounts receivable turnover ratio.
7. Provide incentives
Clients who have an incentive to pay early (and a strong disincentive to pay late) are more likely to help you meet your goals. Consider discounts for quick repayment, and ensure that you have an effective process for enforcing payment timelines and collecting late debts.
8. Implement a collection strategy
A well-defined collection strategy can streamline the process of recovering overdue accounts and maintaining your cash flow. Develop a plan that includes sending regular payment reminders, following up on overdue accounts, and escalating the collection process if necessary. Make sure your collection strategy complies with local regulations, and consider engaging a professional collection agency if your internal efforts are not successful.
9. Monitor key performance indicators (KPIs)
Regularly monitoring KPIs related to accounts receivable can help you identify areas for improvement and measure the effectiveness of your strategies. Examples of relevant KPIs include days sales outstanding (DSO), the percentage of overdue accounts, and the average age of accounts receivable. By tracking these metrics, you can gain insights into your accounts receivable performance and make data-driven decisions to optimize your processes.
10. Train your accounts receivable team
Your accounts receivable team plays a crucial role in maintaining a healthy cash flow. Invest in training to ensure they have the skills and knowledge required to manage credit, collections, and customer relationships effectively. This may include courses on negotiation, communication, credit management, and relevant legal regulations. A well-trained team will be better equipped to handle challenges and contribute to improving your accounts receivable turnover ratio.
11. Automate accounts receivable processes
There are many steps involved in collecting, reconciling, and processing payments from clients; this creates too many opportunities to introduce delays and errors. AR automation software can bring many common tasks under tighter control. Employees can review information and make corrections as needed, but the likelihood of mistakes through manual errors or delays due to employee work schedules drops dramatically.
Corcentric increases your accounts receivable turnover
Most companies could stand to benefit from improving their accounts receivable turnover rate. For many businesses, this involves automating most processes so that employees can focus their efforts on measuring performance and meeting goals for improvement. Corcentric provides a suite of services and solutions that can integrate your invoicing, accounts payable, accounts receivable, and payments systems in a way that operates seamlessly – including Managed AP and Managed AR offerings. Our high standards for usability and accuracy help to ensure that you can run your accounts receivable processes efficiently, increasing your accounts receivable turnover.
To learn more about optimizing cash flow contact us or email us at [email protected].