Accounts receivable turnover ratio: Formula, definition, importance, and examples  

Unpaid invoices create problems for any small company, squeezing cash flow.

So how can you prevent this situation and allow your business to breathe?

The first step is to calculate your Accounts Receivable Turnover Ratio (ARTR), which can also boost the long-term financial health of your business. 

The accounts receivable turnover ratio measures how efficiently you are collecting payments (receivables) owed by your customers.

Simply put, it shows how frequently you collect the average amount owed (accounts receivable) during a specific period.

This ratio helps you see how quickly your customers are paying their invoices.  

This article explains how ARTR works and how you can use this metric to best effect. 

Here’s what we’ll cover:

What is the accounts receivable turnover ratio?

The accounts receivable turnover ratio compares net credit sales against your average accounts receivable status over a given period.

This tells you how efficiently you’re converting receivables into revenue. 

Your incoming revenue dictates your cash flow and ultimately, your company’s financial health.

If you’re generating plenty of revenue and have spending under control, you should have the cash to cover costs, make accurate forecasts, strategise, and invest for growth.

Therefore, tracking and improving the turnover directly impacts your cash flow.

A healthy ratio allows for better financial planning and reduces the risk of cash flow shortages.   

You can evaluate your accounts receivable turnover by benchmarking it against the average for your industry or niche. 

Why AR turnover ratio is important for your business 

There is no defined “highest” AR turnover ratio number.

A higher number simply indicates that your credit policies are effective and customers are paying promptly, meaning you’re collecting efficiently.

However, a very high number could suggest overly strict credit terms, potentially deterring some customers. 

If your business can handle it, you may deliberately aim for a lower ratio so that other operating metrics become attuned to attracting customers with better credit terms.

Conversely, a low ratio suggests clients are taking too long to pay.

This could be because of poor management or credit policies, or a riskier customer base—your credit policies may be too lenient, or too much of your customer base is simply slow to pay. 

While the AR turnover mainly reflects your positioning for cash flow, it indirectly affects other aspects of your operation.

Chief among these are:  

Forecasting

The ARTR is an important assumption for balance sheet and cash flow forecasts, influencing the precision of your financial predictions.

Incorporating this metric into financial models provides a more realistic view of future cash inflows, adding weight to your strategic planning.  

Investor confidence

A high turnover ratio demonstrates the company’s ability to manage its receivables effectively and maintain liquidity.

This naturally boosts investors’ trust in your business.  

If you have a lower AR ratio than you want, there are ways to fix it.

But first, you need to make the right calculations to understand your receivable ratios, including your AR turnover and average days-to-pay (also known as day ratio). 

How to calculate accounts receivable turnover ratio  

Your credit sales don’t exactly measure revenue because they haven’t been paid yet.

Likewise, your accounts receivable balance isn’t the same as revenue—it only represents the portion of credit sales that remains unpaid at any particular time.  

However, the relationship between these two figures does help you understand how quickly your business is converting sales into cash.

Here’s how it works on paper: 

Accounts receivable turnover ratio formula  

ARTR = Net credit sales / Average accounts receivable 

Here, net credit sales refers to sales made on credit, minus any returns, discounts or allowances.

It’s a figure that accumulates over the period you’re measuring.   

Meanwhile, accounts receivable is a fluctuating balance, providing a snapshot at a specific moment.

To make a meaningful comparison, you need an AR figure that represents the entire period rather than just one point in time.

That’s why you use the average accounts receivable—the average of all recorded AR balances throughout the analysis period. 

How to calculate accounts receivable turnover in three steps 

So the accounts receivable turnover formula is fairly simple, but you still need to fit it into your overall accounts receivable process.

Here’s how: 

Gather the required data

For the period you’re measuring, collect the net credit sales total and accounts receivable balances.

These are available in your income statement and balance sheet. 

Calculate the average accounts receivable

Add your beginning and ending accounts receivable balances and divide by two. 

Run the formula

Divide your net credit sales by your average accounts receivable. 

Accounts receivable turnover example 

Here’s what the calculation could look like in practice: 

Let’s say your company had £500,000 in net credit sales during the year. And your accounts receivable balance varied between £50,000 and £200,000 each month.  

The average over 12 months was £125,000.

That implies that the sum of AR figures over the 12 months was much more than the £500,000 in sales—but that’s entirely plausible because some amounts could carry over from month to month. 

Accounts receivable turnover ratio is: £500,000 / £125,000 = 4 

This result means your company collected its average accounts receivable four times during the year. 

What is a good accounts receivable turnover ratio? 

A “good” ARTR varies significantly by industry. For example, what’s “high” for a grocery store might be “low” for a construction company.

Grocery stores deal with perishable goods, so they often expect rapid turnover due to frequent transactions.  

The only way to truly know your status is to compare your AR turnover to industry benchmarks, which are available through industry-specific financial reports or business associations.

Aim for a ratio that aligns with or exceeds your industry’s average, signalling healthy cash flow management. 

However, a high turnover ratio generally indicates efficient collection, while a low ratio suggests slow-paying customers. Let’s look at these aspects in more detail. 

High ratio 

A very high ARTR indicates that your company is collecting receivables quickly, suggesting efficient credit and collection practices. 

However, extremely high ratios should be examined carefully.

They might indicate overly restrictive credit policies that deter potential customers, limiting sales growth.

While efficient, it’s important to balance rapid collection with maintaining strong customer relationships and competitive credit terms. 

Low ratio 

If your ratio is consistently low, this implies potential cash flow issues, and you may have valuable working capital tied up, which could hinder growth.  

Investigate the root cause: are customers struggling financially, or is there a technical issue obstructing payments? Analyse customer payment patterns and credit policies. 

If necessary, tighten credit terms to encourage prompt payment, improve collection efforts, or reassess your customer base. 

Case study 

To see how this works in practice, consider the case of a small firm we’ll call “Maria’s Bakery”.  

The bakery has expanded its customer base by extending credit to small business owners.

At the end of the first year doing this, the company’s AR turnover ratio was 8.2—meaning it gathered its receivables 8.2 times for the year on average. 

The bakery can calculate the day ratio by dividing the number of days in the year (365) by the turnover ratio.

In Maria’s case, this is 365/8.2 = 44.5, which means it takes her just under 45 days to collect from customers. 

This is fine if the company has a 45-day payment policy—customers are paying within the terms and the system is running smoothly.

If cashflow problems arise, it may just need to reduce the payment term. 

But if Maria deems that invoices need to be paid in 30 days, a 44.5 day ratio could indicate she is extending credit to lower quality customers, or the collection department is not effective. 

The bakery could compare this ratio to industry peers to see if it’s an outlier. If similar businesses have a lower day ratio, say 40, Maria’s Bakery could consider how to improve its ratios to make the business more competitive. 

Typical AR turnover ratio benchmarks 

The bakery case is quite typical of retail in general, although higher rates are more common.

This is because retail businesses tend to have high volumes of cash and credit sales. Grocery stores, in particular, often have daily or weekly turnover.

The standard range for retail is 2 to 20 or higher. 

Manufacturing 

Manufacturers generally have longer credit terms with their business customers.

This is because orders are often large and expensive, and more time is required to produce the goods compared to retail.

Manufacturers may also have more complex billing cycles.

The typical range here would be 4 to 8. 

Services  

Service-based businesses such as consulting or IT often have shorter payment terms than manufacturers but longer than retailers.

Factors such as project duration and client payment practices can influence the ratio, which generally falls between 6 and 12. 

Healthcare 

Healthcare providers often face longer payment cycles due to the time required to process insurance claims and the high cost being spread across patient payment plans.

Also, this industry can be heavily effected by economic conditions, further impeding rapid turnover. This gives typical AR rates of 3 to 6. 

How to improve your accounts receivable turnover ratio 

Improving your ARTR requires a multi-faceted approach.

It may involve optimising your internal processes, or proactively managing customer accounts. Whatever the case, the key is to identify and address potential payment issues early.

Let’s look at four key areas that can impact the AR turnover ratio: 

Strengthen credit policies 

Beyond setting basic terms, strengthening credit policies involves assessing your customer’s creditworthiness before extending credit. Implement a formal credit application process, including thorough background checks.

Establish credit limits based on customer financial stability.

Regularly review and update credit limits to reflect changing customer circumstances.  

Consider using credit scoring systems to automate credit risk assessment, and offering early payment discounts to incentivise prompt payments.

Develop a clear escalation process for overdue accounts, outlining collection procedures at each stage.

Document all credit-related communication to maintain transparency and accountability.  

Automate invoicing and payment reminders 

Automation drastically reduces overdue payments through timely and consistent communication.

The main feature of this is automatic payment reminders, sent before due dates to minimise missed payments.

Your accounting software should also be able to instantly generate and send invoices as soon as transactions are agreed.   

These systems also produce reports on outstanding invoices, enabling you to prioritise collection efforts.

Furthermore, implementing a system for tracking and prioritising collections ensures that follow-ups are consistent and efficient.

Regular reviews of your automated AR processes help identify and eliminate bottlenecks, further optimising your cash flow. 

Offer multiple payment options 

Flexible payment methods increase collections by catering to diverse customer preferences, giving them the opportunity to pay more promptly.

Their preferred methods could include online payment portals, bank transfers, credit cards, and digital wallets.

Not only are these convenient for your clients, but they are inherently faster, bypassing manual processing.

Providing multiple payment options also demonstrates customer-centricity, fostering goodwill and loyalty.  

Optimise payment terms 

Having adjusted your credit policies, you’ll be in a position to strategically define invoice payment terms for each client.

Choose the best option to cater to customer needs while incentivising prompt payments. Common examples are: 

Net 30

You grant the customer 30 days from the invoice date to make full payment.

It’s a standard option that provides flexibility for businesses with longer payment cycles. 

Early payment discounts

For example you might offer a 2% discount if the customer pays within a 10 days (denoted as 2/10 Net 30).

This encourages faster payments and improves cash flow. 

Due on receipt

This means immediate payment as soon as the customer receives the invoice.

It’s often used for smaller transactions or when prompt payment is essential. 

Instalments

Dividing large purchases into smaller, scheduled payments. Often used for long term projects, or high value purchases.  

Clearly communicate these terms in your contracts and invoices, detailing due dates, penalties, and accepted payment methods.

Analyse industry standards and customer reliability to determine the most effective terms for your business, balancing cash flow needs with customer relationships.

Most accounting software is designed to allow customisation of payment terms so make use of this feature to clearly state what your expectations and client obligations are. 

Improve customer relationships 

While automation provides the means for good communication, this is also a matter of willingness and effort.

It pays to promptly and professionally address customer inquiries, demonstrating your commitment to their needs.  

On top of that, personalised communication shows that you value their business, further strengthening the relationship.

Consistent follow-up on overdue invoices is essential, but it’s more effective when combined with a positive and supportive relationship.  

Regular and transparent communication builds a sense of partnership, fostering trust and rapport, and motivating customers to prioritise timely payments.  

Final thoughts 

To streamline accounts receivable management and improve turnover, consider using purpose-built accounts receivable software.

A good solution automates much of the AR process, giving you a solid path to better tracking, invoicing, and collections. 

The resulting improvements in efficiency, customer relations and profitability can boost your financial health and the overall success of your business.

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