It is best to use average accounts receivable to avoid seasonality effects. If the company uses discounts, those discounts must be taken into consideration when calculate net accounts receivable. Accounts receivable represents the indirect interest free loans that the company is providing to its clients. Therefore, it is very important to know how “costly” these loans are for the company. A high receivables turnover ratio implies either that the company operates on a cash basis or that its extension of credit and collection of accounts receivable are efficient.
Also, a high ratio reflects a short lapse of time between sales and the collection of cash, while a low number means collection takes longer. The lower the ratio is the longer receivables are being held and the risk to not be collected increases. A low receivables turnover ratio implies that the company should re-assess its credit policies in order to ensure the timely collection of credit sales that is not earning interest for the firm.
A ratio that is low by industry standards will generally indicate that your business needs to improve its credit policies and collection procedures. If the ratio is going up, either collection efforts may be improving, sales may be raising or receivables are being reduced. Receivables turnover ratio is figured as “turnover times”. A popular variant of this ratio is to convert it into an average collection period in terms of days.
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