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Receivables Turnover

The receivables turnover ratio is calculated by dividing total sales by average receivables during the period. We use net receivables for this calculation, that is, we subtract an allowance for bad debts before calculating average receivables.

We can also calculate the average collection period by dividing the number of days in a year (365) by the receivables turnover ratio.

We look at the receivables turnover ratio as shedding light on the firm’s ability to manage its investment in accounts receivable. This gives us information about a firm’s credit policy.  A firm with a liberal credit policy will have a higher average collection period, a higher amount of receivables and a lower receivables turnover ratio.  A restrictive credit policy will show a lower average collection period, a lower average receivables, and a higher receivables turnover ratio.

We can also compare the average collection period to the terms of credit provided to customers. If we expect customers to pay us within 30 days, and we have an average collection period of 60 days, we know our credit policy is too liberal. The general rule of thumb is that the average collection period should not be more than the amount of time allowed for payment by the firm’s credit terms.