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Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio measures how frequently a company converts its receivables in to cash. We know that accounts receivable is a current asset; however it may not be liquid enough if the debtors are in a bad financial position and cannot pay their dues. If this happens, then this means the company’s current assets will be grossly overvalued because it is not expecting to collect a majority of its receivables (these will have to be written off from AR). The accounts receivable turnover ratio is calculated as follows:

Accounts Receivable Turnover = Net Sales / Average Accounts Receivable

The net sales number is derived from the income statement; however a better number to report on the numerator would be Credit sales. However, most companies do not record credit sales, thus this information is not available. In the denominator, the average accounts receivable also includes short-term notes receivables from customers.

Average accounts receivable are estimated by averaging the beginning and ending receivable balances for the period. If this data is not available, then an average of quarterly or monthly receivables can be used. Also some companies prefer to simplify things by substituting the ending accounts receivable balance as the average balance, and thus not having to worry about calculating the beginning balance.

Juakali Corp.
Comparative Income Statement
As of December 31st, 2004

Sales $236,589.00
Less: Cost of Goods Sold $56,900.00
Gross Profit $179,689.00
Expenses: $102,335.00
- Advertising & Marketing Expense $21,630.00
- General & Admin expense $54,550.00
- Research & Development $20,000.00
- Amortization expense $6,521.00
- Loss (gain) on foreign exchange
Total Expenses $104,701.00
Income from Continuing Operations $74,988.00
- Interest Income $9,750.00
Less: Interest Expense $4,000.00
Income from Continuing Operations before taxes $80,738.00
- Income Taxes $28,000.00
Net Income $52,738.00

To calculate the accounts receivable turnover ratio, we need to reference the income statement to derive the Net sales number. Thus, here is the AR turnover ratio calculation:

Accounts Receivable Turnover = Net Sales / Average Accounts Receivable

Accounts Receivable Turnover = $236,589 / ( ($65,425 + $83,641) / 2)

Accounts Receivable Turnover = $236,589 / $74,533

Accounts Receivable Turnover = 3.174

This number means Juakali Corp. collects all its average accounts receivable 3.174 times in a year; the higher this number, the better it is for the company and its investors. A high AR turnover ratio is warranted because this means the company is not having problems collecting its receivables, thus it does not need as many employees for making collection calls and chasing the customers. However to get a true picture of whether this ratio is good, always compare it with how companies within that industry are doing.

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