As a retail business owner, maintaining a healthy cash flow is essential for sustainable growth and long-term success. One of the most crucial metrics for understanding your business’s financial health is the accounts receivable turnover ratio. This financial health KPI reveals how efficiently your business collects payments from customers who make purchases using credit, directly impacting your cash flow and overall financial stability.
Understanding and optimizing your accounts receivable turnover ratio can dramatically improve your business’s financial performance. Below, we’ll explore what the accounts receivable turnover ratio is, why it matters, and most importantly, how you can improve it to enhance your business operations.
What Is an Accounts Receivable Turnover Ratio?
The accounts receivable turnover ratio—also known as the AR turnover ratio, receivable turnover, or debtors turnover— is a financial metric that measures how effectively your business collects payments from customers who purchase on credit. Your receivables turnover ratio indicates how many times during an accounting period your company collects its average accounts receivable.
When we talk about the turnover ratio in retail, we’re essentially measuring the relationship between your net credit sales and your average accounts receivable balance. A higher turnover ratio indicates that your company collects payments more quickly, while a lower ratio suggests it takes longer to collect what customers owe.
A low accounts receivable turnover ratio typically indicates inefficiencies in your collections process. It’s also typically associated with cash flow issues and less liquidity.
Why Your Accounts Receivable Ratio Turnover Matters
Your accounts receivable turnover rate directly impacts your business’s cash flow and operational efficiency. When your business maintains a strong receivable turnover, you’re better positioned to meet financial obligations, invest in growth opportunities, and maintain healthy relationships with suppliers.
A high AR turnover ratio indicates efficient credit and collection processes, suggesting your business effectively converts credit sales into cash on a consistent basis. This efficiency is particularly crucial in retail, where managing inventory, paying suppliers, and maintaining operations requires consistent cash flow.
Your receivables turnover also serves as an important indicator of your credit policies’ effectiveness as it can help you understand whether your current credit terms are working well for both your business and your customers. Moreover, calculating and tracking your accounts receivable turnover ratio over time can reveal trends as well as potential issues before they become serious problems. It’s also a useful metric for revenue forecasting, as the AR ratio can give you a clearer view of the time it takes to convert your credit revenue into cash.
What Is a Good Accounts Receivable Turnover Ratio?
Understanding what constitutes a good accounts receivable turnover will vary by industry and business model, but there are general benchmarks you can follow to determine where yours stands. For retail businesses, the optimal receivable turnover typically falls between 21 and 34 days.
Here’s a breakdown of what different ratios typically indicate:
- An “excellent” or high turnover ratio of 12 or above shows exceptional efficiency in collections, indicating your business converts credit sales to cash approximately every 30 days or sooner. This represents the ideal accounts receivable management that you want to work towards.
- A “good” accounts receivable turnover ranging from 8 to 11 suggests healthy collection practices and effective credit policies. Most successful retail businesses maintain ratios within this 33- to 45-day range.
- Ratios between 6 and 7 indicate an average performance of around 60 days, suggesting some room for improvement in collection processes and credit policies.
- Ratios below 6 signal potential issues with your collection processes or credit policies that need immediate attention. This lower ratio means your average accounts receivables are taking longer than 60 days to collect—which is too long.
How to Calculate Your Accounts Receivable Turnover Ratio
Calculating your accounts receivable turnover ratio is relatively easy. To get started, you’ll need to understand the basic formula and the components involved. The formula takes your net credit sales divided by your average accounts receivable.
Your net credit sales are the total amount of sales made via credit minus returns and allowances. Your average accounts receivable (ACR) is the average amount of money your customers owe to your business over a period of time. ACR is calculated by adding the beginning and ending ACR balances and dividing them by two to get the average. This means you’ll have to do a series of small calculations to get the numbers you need for your accounts receivable turnover ratio (ARTR) formula, which is denoted as follows:
ARTR = Net Credit Sales / Average Accounts Receivables
Here’s an example:
Let’s say your retail business had $500,000 in total credit sales for the year, with sales allowances and returns of $20,000. Your accounts receivable balance was $60,000 at the beginning of the year and $40,000 at the end.
- The first step is to calculate your net credit sales by subtracting returns and allowances from total credit sales: $500,000 – $20,000 = $480,000
- Next, you would determine your average accounts receivable by adding the beginning and ending balances and dividing that number by two: ($60,000 + $40,000) ÷ 2 = $50,000
- Finally, divide your net credit sales average by your average accounts receivable: $480,000 ÷ $50,000 = 9.6
This means your business collects its average accounts receivable 9.6 times per year. To find the number of days it takes for these collections to convert, you would simply calculate the average collection period by dividing 365 days by your average AR.
In this example, that calculation would look like this: 365 ÷ 9.6 = ~38, which is considered a good ARTR.
How to Improve Your Accounts Receivable Turnover Ratio
There are plenty of methods you can use to improve your AR turnover ratio. If you choose to use BrightPearl for your inventory management and forecasting needs, you’ll be able to automate several of those methods to achieve a better accounts receivable turnover ratio.
Here are some tips on how to improve your AR turnover ratio, along with the ways in which BrightPearl can help:
Implement Clear Credit Policies
Establishing clear, written credit policies is fundamental to improving your accounts receivable turnover. Your credit policies should outline specific terms, credit limits, and consequences for late payments. Consider implementing credit checks for new customers and regularly review the creditworthiness of existing ones. This proactive approach helps minimize the risk of late payments and bad debt.
Optimize Billing Processes
Streamlining your billing processes with modern technology can significantly impact your receivable turnover. BrightPearl’s retail operating system (ROS) offers automated invoice billing features that can help reduce errors, speed up invoice delivery, and improve overall collection efficiency. By sending accurate invoices promptly and automatically, you’re more likely to receive timely payments.
Offer Early Payment Incentives
Implementing early payment discounts can motivate customers to pay sooner rather than later. Consider offering a small percentage discount for payments made within a specified period, such as 2% if paid within 10 days. This strategy can help improve your credit sales average accounts while maintaining positive long-term customer relationships. It can also be implemented with ease through BrightPearl’s settlement discount feature.
Automate Payment Reminders
Using automated reminders— such as those through BrightPearl’s ROS system— can help ensure customers never forget about upcoming or overdue payments. With BrightPearl, you can set up a sequence of friendly but firm reminders at strategic intervals before and after due dates. This systematic approach helps maintain consistent communication without straining your team’s resources.
Diversify Payment Options
Make it as easy as possible for customers to pay you by offering multiple payment methods. Accept credit cards, electronic transfers, and other popular payment options. BrightPearl’s integrated payment solutions can help you manage various payment methods efficiently while maintaining accurate records of your accounts receivable.
Monitor and Analyze Performance
Regularly track your accounts receivable turnover calculated metrics using BrightPearl’s advanced reporting tools. Monitor trends, identify potential issues early, and adjust your strategies accordingly. This data-driven approach helps you maintain optimal performance and make informed decisions about credit policies.
Strengthen Collection Procedures
Develop and implement robust collection procedures for overdue accounts. Train your staff on professional collection techniques and establish clear escalation protocols. Consider using BrightPearl’s automation features to streamline this process and ensure consistent follow-up on overdue accounts.
Improve Customer Communication
Maintain open lines of communication with customers about their payment obligations. Send regular account statements, provide clear payment instructions, and address any disputes promptly. Building strong customer relationships while maintaining professional payment expectations can help improve your overall receivables turnover.
Remember that improving your accounts receivable turnover ratio is an ongoing process that requires consistent attention and refinement. With the right tools and strategies in place, you can achieve and maintain an optimal turnover ratio that supports your business’s growth and success.
By implementing the above strategies while utilizing BrightPearl’s comprehensive retail operating system, there’s no doubt that you will significantly improve your accounts receivable turnover ratio quickly. The system’s integrated approach to managing credit sales, cash sales, and accounts receivable helps streamline your operations and maintain healthy cash flow.
Want to learn more about how BrightPearl can help you optimize your accounts receivable management? Book your free demo today and discover how our integrated retail operating system can transform your business’s overall financial performance through precise inventory management.
