How to Compute Accounts Receivable Turnover and the Age of Receivables
In order for the accounts receivable turnover rate to be significant, it is compared with what is prevailing in the industry.
Let us take a look on how to calculate the accounts receivable turnover:
The formula is:
Account Receivables Turnover = Credit Sales divided by Average Receivable
Utilizing the data taken from Mighty King Trading:
Accounts Receivable, January 31, 2009, $30,000
Accounts Receivable, December 31, 2009, $10,000
Cash Sales $50,000
Credit Sales $160,000
To get the average receivables: Account Receivables, January 1, $30,000 - plus Accounts Receivables, December 31, $10,000 equals $40,000. $40,000 divided by 2 equals $20,000.
To get the Accounts Receivable Turnover: Credit Sales, $160,000 divided by the Average Receivables equals 8.
To get the average collection period: 360 days in a year divided by the accounts receivable turnover or 360 days divided by 8 times is equal to 45 days. This standard of days is compared to the number of days allowed in the company's credit term. If the credit policy allows only 30 days for credit accounts, then the company is performing below the standard. It means to say that the collection system is not efficient.