The receivables turnover ratio measures how fast a company can convert its receivables into cash. This is done by calculating the number of times a company collects receivables during a single period. The higher the ratio, the greater the number of collections undertaken during a single period and the more liquid a company's receivables are.
Formula:
Receivables Turnover = Net Credit Sales/ Average Net Receivables
1- Net Credit Sales = Net Sales - Cash Sales
2- Average Net Receivables = (Net Receivables Beginning + Net Receivables End) / 2
Example:
Adequate Disclosure, Inc. plans to analyze the financial statements of Inadequate Disclosure, Inc. The industry average is 2.4. Should Adequate Disclosure, Inc. invest into Inadequate Disclosure, Inc.?
- 356,000 / (200,000 + 120,000/2)
- 356,000 / (320,000/2)
- 356,000 / 160,000 = 2.25
No, Adequate Disclosure, Inc. should not invest into Inadequate Disclosure, Inc. since the receivables turnover ratio is lower than the industry average.