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Accounts receivable turnover and Age of accounts receivable

In any business the ability to convert accounts receivables (or credit sales) into cash is an important measurement of management's efficiency. These two ratio's give investors a decent appraisal of a company's ability to collect on credit.

To calculate accounts receivable turnover & age of accounts receivable:

Accounts receivable turnover = (net credit sales / average net accounts receivable)

Age of accounts receivable = 365 days / accounts receivable turnover

The values of each ratio will vary from industry to industry and research should be done also into a companies credit terms to give an idea of whether the management is effective or not. For example if a company has a 60 day credit term it would be unreasonable to expect an age of accounts receivable value which is significantly less than 60 days.

Some computational side notes:

  • It is important to only use credit sales when calculating accounts receivable turnover and age of accounts receivable.
  • The investor should use the average monthly receivables rather than the ending balance of accounts receivable. This will remove any seasonal fluctuations. To calculate the average monthly receivables add the 13 monthly balances (Jan1, Jan31-Dec31) and divide by 13. If the investor cannot get the monthly balances the average of the beginning of year and end of year balance should be used.