The performance of the business can be evaluated by having an insight into its financials. To build up a strong credibility before its lenders, a business must strengthen its financial ratios. The financial ratios can be classified into four main categories, namely, liquidity ratios, profitability ratios, solvency ratios and activity ratios. Activity ratios are the financial tools that are used to evaluate the ability of the firm to convert its assets into cash or cash equivalents. One such important ratio is Receivables Turnover ratio.
Receivables Turnover ratio, which is also referred to as ‘debtors turnover ratio’, measures the efficiency with which the company is able to convert its accounts receivables into cash. It is an indicator of how well the business is able to maintain its policy of extending credit to its debtors.
Receivable turnover ratio can be calculated as below:
Receivables Turnover Ratio = Net Credit Sales/ Average Accounts receivables
It should be noted that only credit sales are taken into account for calculating receivables turnover ratio since cash sales do not create accounts receivables. Average accounts receivables is calculated by simply adding opening and closing accounts receivables and dividing the total by two.
Take for example, your business has a net credit sales of Rs 8,00,000 and average accounts receivables of Rs 40,000, the receivables turnover ratio would be 20 times (Rs 8,00,000 divided by Rs 40,000). This number indicates that your firm has been able to collect cash from debtors 20 times during the accounting period.
As a matter of fact, higher the receivables turnover ratio, the better it is. A higher receivable turnover ratio indicates that the your firm has been able to collect its accounts receivables higher number of times during the reporting period. Sooner the credit sales/ debtors are realised into cash, lower is the requirement of working capital for the business. This also indicates lesser chances of defaults on part of customers. Efforts should be made to strenghten a company’s credit policy and the policy should be reassessed on a periodical basis to increase the receivables turnover ratio.
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