Definition of Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio (AR turnover ratio) measures how efficiently a business collects payments from customers within a specific period. It indicates how often a company converts its accounts receivable into cash, reflecting its credit policies and collection effectiveness.

A higher ratio suggests a company collects payments quickly, while a lower ratio may indicate delayed collections or credit risk.

For example, a Canadian retail business with an AR turnover ratio of 10 means it collects and reinvests receivables 10 times per year.

Purpose of the Accounts Receivable Turnover Ratio in Business

The AR turnover ratio is essential for cash flow management and financial analysis, helping businesses:

1. Evaluate Credit Policies – Assess how well a company manages customer credit.
2. Measure Cash Flow Efficiency – Determine how quickly receivables are collected.
3. Identify Collection Risks – Detect potential cash flow issues due to late payments.
4. Compare Industry Performance – Benchmark financial health against competitors.
5. Optimize Business Growth – Improve revenue cycles and working capital management.

How to Calculate the Accounts Receivable Turnover Ratio

Formula

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable​

Steps to Calculate:

1. Determine Net Credit Sales – Exclude cash sales and refunds from total revenue.
2. Find Average Accounts Receivable – Calculate:

   Average AR = Beginning AR + Ending AR / 2​

   

3. Apply the Formula – Divide net credit sales by average AR.

Example Calculation

A manufacturing company in Canada reports:

• Net Credit Sales: $500,000
• Beginning Accounts Receivable: $40,000
• Ending Accounts Receivable: $60,000

Average AR = 40,000 + 60,000 / 2 = 50,000
AR Turnover Ratio = 500,000 / 50,000 = 10

This means the company collects its outstanding receivables 10 times per year.

What Is a Good Accounts Receivable Turnover Ratio?

The ideal ratio varies by industry:

Industry	Average AR Turnover Ratio
Retail	8 – 12
Manufacturing	5 – 10
Healthcare	3 – 7
Professional Services	6 – 9

A higher ratio indicates efficient collections, while a lower ratio suggests potential cash flow risks.

Accounts Receivable Turnover vs. Days Sales Outstanding (DSO)

Metric	Definition	Indicates
AR Turnover Ratio	Measures how many times receivables are collected per year.	Collection efficiency.
Days Sales Outstanding (DSO)	Measures the average number of days to collect receivables.	Payment speed.

The formula for DSO:

DSO = 365 / AR Turnover Ratio​

For a business with an AR turnover ratio of 10, the average collection period is:

365 / 10 = 36.5 days

This means it takes approximately 37 days to collect outstanding payments.

Advantages and Disadvantages of the Accounts Receivable Turnover Ratio

Advantages

• Improves Financial Planning – Helps manage working capital.
• Identifies Collection Issues – Detects slow-paying customers.
• Enhances Credit Policy Decisions – Ensures customers pay on time.
• Boosts Cash Flow Stability – Supports steady revenue cycles.

Disadvantages

• Does Not Show Profitability – A high ratio does not mean a business is profitable.
• Varies by Industry – Different industries have different benchmarks.
• Ignores External Factors – Seasonal trends or economic downturns can impact collections.

Best Practices to Improve the Accounts Receivable Turnover Ratio

1. Strengthen Credit Policies – Set stricter credit approval processes.
2. Offer Discounts for Early Payments – Encourage faster collections.
3. Automate Invoicing & Collections – Use QuickBooks, Xero, or Sage for tracking.
4. Follow Up on Late Payments – Send reminders and enforce penalties for overdue accounts.
5. Negotiate Better Payment Terms – Align receivables with business cash flow needs.

Interesting Fact

Did you know? Canadian businesses with high AR turnover ratios often qualify for lower-interest loans, as lenders see them as having strong cash flow management.

Statistic

According to CPA Canada, over 55% of small businesses in Canada experience cash flow shortages due to slow accounts receivable collections.

Frequently Asked Questions (FAQ)

1. Why is the accounts receivable turnover ratio important?

It helps businesses measure how efficiently they collect payments from customers.

2. What does a low AR turnover ratio indicate?

A low ratio suggests delayed collections, poor credit policies, or financial instability.

3. How can businesses improve their AR turnover ratio?

By automating invoicing, enforcing credit policies, and following up on late payments.

4. What industries have the highest AR turnover ratios?

Retail and fast-moving consumer goods (FMCG) industries typically have the highest ratios.

5. Is a higher accounts receivable turnover ratio always better?

Not necessarily. A high ratio might indicate that a company is too restrictive with its credit policies, potentially resulting in customer loss.