accounts receivable
Accounts receivable turnover represents the average number of times per year that trade receivables "turn over" or are converted to cash. Higher, more rapid turnover is favorable, since sales on credit are being converted to cash more quickly. Lower, less rapid turnover is unfavorable since default becomes more likely as receivables remain uncollected, and since conversion to cash is necessary to service obligations or to earn interest.
A problem with this ratio is the fact that it compares accounts receivable at a single point in time to an entire year of sales. If the accounts receivable balance is unusually high or low on the date of the financial statements due to seasonal variations or other factors, then this measurement may not provide an accurate picture. Substituting average receivable balances over the year in the denominator, may help correct this.
Accounts receivable turnover represents the average number of times per year that trade receivables "turn over" or are converted to cash. Higher, more rapid turnover is favorable, since sales on credit are being converted to cash more quickly. Lower, less rapid turnover is unfavorable since default becomes more likely as receivables remain uncollected, and since conversion to cash is necessary to service obligations or to earn interest.
A problem with this ratio is the fact that it compares accounts receivable at a single point in time to an entire year of sales. If the accounts receivable balance is unusually high or low on the date of the financial statements due to seasonal variations or other factors, then this measurement may not provide an accurate picture. Substituting average receivable balances over the year in the denominator, may help correct this.
Another potential problem exists when cash sales represent a large percentage of total revenues. The ratio will be very favorable in this case. A more useful measure may be taken by considering only sales on credit in the numerator. Such a ratio is probably best used only in comparison with the company’s own historical turnover and with the actual payment terms the business requires of its customers.
ReplyDeleteAlso, note that the numerator consists of annual sales. The ratio is only useful when annualized sales are used. If you are analyzing interim statements, then sales should be annualized before being plugged into the formula. For example, if the income statement is dated May 31, and it represents five months of operations, then you would multiply sales by 12/5 to annualize them for use in this ratio. Like the accounts receivable balance, sales for an interim period may be skewed if the period represents a particularly slow or busy time of the year. Keep this in mind when analyzing accounts receivable turnover for partial years.
ReplyDelete