Accounts Receivable Turnover Example
To emphasize it’s importance we will provide an accounts receivable turnover example. Many companies live and die by collections. These rates are essential to having the necessary cash to cover expenses like inventory, payroll, warehousing, distribution, and more.
Accounts Receivable Turnover Example: Manufactco
Manufactco is a company that manufactures widgets. Manufactco’s widgets have become very popular. The company is growing quickly and must hire new employees for their plant.
Annual Credit Sales: $10,000 Accounts Receivable in 1/1/09: $2,500 Accounts Receivable in 12/31/09: $1,500
Currently, Manufactco’s accounts receivable turnover rate is:
$10,000/ (($2,500 + $1,500)/2) = 5 times
Every company should have someone tasked as, amongst other bookkeeping matters, head accounts receivable turnover calculator. This person is known as a Chief Financial Officer (CFO). She has found that a full turnover happens 5 times in one year. To rephrase, in a full year all open accounts receivable are collected and closed 5 times. This is the accounts receivable turnover ratio meaning.
Accounts Receivable Turnover
Now let’s make things a bit more complicated. How many accounts receivable turnover days will it take to complete one cycle?
Simply use this formula: Days Receivable Outstanding = # of days / accounts receivable ratio calculation
Many companies Google “accounts receivable turnover ratio calculator”, look towards their BA II, or scour their local bookstore. A properly trained CFO, however, has the answers to this and many other questions.
The period for this example begins at 1/1/09 and ends at 12/31/09. The number of days for this period, then, would be 365. Manufactco’s accounts receivable equation for the number of days a receivable is outstanding is:
365 days / 5 times = 73 days for A/R to turnover
Conclusion
In conclusion, all open accounts receivable are collected and closed every 73 days. In 73 days, customers do all of the following:
- Make a purchase
- Are reminded that payment is due
- Send payment
- Save payments processed
- Save receivable accounts closed
The Chief Financial Officer of Manufactco now knows that 5 full turnovers happen in a year. She also knows that it takes 73 days for one full turnover to occur. Creating a profitable company is now a simple matter.
Tightening credit policies is one common method. Options include the following:
- Decreasing the amount of days allotted before payment is due,
- Including or increasing discounts for early payment, or
- Increasing the late payment penalty fee
Additionally, she could update collections technologies or simply increase collections staff. In extreme conditions Manufactco could even stop serving certain customers, in effect “firing” those who are late or non-paying. All of these tools are available for the clever CFO.
For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.
[box]Strategic CFO Lab Member Extra
Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.
Click here to access your Execution Plan. Not a Lab Member?
Click here to learn more about SCFO Labs[/box]
See Also:
Accounts Receivable Turnover Analysis
