Accounts Receivable Turnover is used to see how much cash a company can collect from its credit customers. As accounts receivable's increase, sales revenue increases but cash does not. Cash is collected once the accounts receivable is paid in full. In addition, the longer the buyer does not pay for the credit sale; the more likely it will become uncollectible.
Here is the theory in the form of journal entries:
On January 1st, Adequate Disclosure, Inc. performs tax services for Inadequate Disclosure, Inc. Inadequate Disclosure, Inc. pays by signing a non-interest bearing note of $45,000. Record the journal entry on Adequate Disclosure, Inc.’s books on January 1st.
On February 15th, Inadequate Disclosure pays in cash the full amount of $45,000. Record the journal entry on Adequate Disclosure, Inc.’s books on February 15th.
It is important to note that on January 1st, cash is not received and on February 15th cash is received. The purpose behind these journal entries is to display how accounts receivable are collected and journalized and also emphasize the importance of collecting an accounts receivable. The Accounts Receivable Turnover formula is used to estimate how much of an entity’s credit sales it can collect within its fiscal year.
The formula is:
Net Credit Sales / Net Accounts Receivable (Average of Beginning & Ending Year Balances) = Accounts Receivable Turnover
Example:
Adequate Disclosure, Inc. is looking to invest into Inadequate Disclosure, Inc. One formula the financial analysts are using is the Accounts Receivable Turnover. The industry average is 1.5. Calculate the Inadequate Disclosure, Inc.’s accounts receivable turnover.
Should Adequate Disclosure, Inc. invest into Inadequate Disclosure, Inc.?
67,000 / (15,000 + 50,000) = 1.03
No, Adequate Disclosure, Inc. should not invest into Inadequate Disclosure, Inc. since it well below the industry average of 1.5.