The InvoiceSherpa Blog

What is a Good Accounts Receivable Turnover Ratio?

Struggling with sluggish payments and tangled in the web of overdue invoices? You're not alone. Many businesses face the challenge of managing their accounts receivable efficiently. 

Overcoming these obstacles starts with an understanding of what your AR turnover ratio is telling you. So, what is a good accounts receivable turnover ratio? 

Higher is better as it means you collect payments rapidly. Some say that an ART ratio of 1 is good, while others aim for figures ranging from 7 or higher. But, we need to provide more context. 

Below, we’ll walk you through calculating your AR turnover ratio and how to decipher what it’s telling you. Then, we’ll offer tips to improve it - such as reaping the accounts receivable automation benefits right here at InvoiceSherpa.

We’ve developed an accounts receivable automation software that saves you time while getting you paid faster, improving relationships with customers, and offering financial clarity. 

Before we get into the role our software plays in SMB financial management, let’s start with the basics: what is the accounts receivable turnover ratio, exactly?

What is the Accounts Receivable Turnover Ratio?

The accounts receivable turnover ratio (ART Ratio) is a key financial metric for any business, acting as a barometer of your company's efficiency in managing and collecting debts. 

In essence, it measures how frequently a business can turn its accounts receivable into cash over a specific period, typically within a fiscal year.

Your business is essentially a pipeline where sales convert into cash. The ART Ratio helps you gauge the flow rate of this pipeline

A high ratio indicates a fast-flowing pipeline, meaning you're quickly collecting debts, which leads to healthier cash flow. Conversely, a lower ratio might signal a clog in your pipeline, indicating slower collection and potential cash flow issues. 

How the AR Turnover Ratio Reflects on Your Business's Financial Health

The health of your business is closely tied to how efficiently you can convert sales into cash. This is where the ART ratio steps in as an essential indicator.

A high ART ratio is often a sign of a well-oiled accounts receivable process, suggesting that your business is proficient in credit policies and collection practices. It indicates that your business is not just making sales, but also efficiently collecting the revenue tied up in those sales.

On the flip side, a low ART ratio can be a red flag, pointing towards potential issues like poor credit policies, ineffective collection strategies, or customer dissatisfaction leading to delayed payments. 

This not only affects your liquidity but can also impact your ability to reinvest in growth opportunities, meet financial obligations, and maintain a solid financial foundation. If you’re constantly dealing with the frustration when an account becomes uncollectible and must be written off, it’s likely time to reassess the way you send invoices and reminders.

How to Calculate Accounts Receivable Turnover Ratio: Step-by-Step Guide 

Understanding and monitoring your ART ratio is vital for maintaining the financial heartbeat of your business. 

It's not just about knowing the numbers, but interpreting what they mean for your business's ongoing and future financial health. 

That being said, let’s take a look at how to calculate the accounts receivable turnover ratio:

  1. Identify Your Net Credit Sales: This is the total sales made on credit over a specific period, typically a year. It's crucial to use net sales (total sales minus returns and allowances) as this reflects the actual revenue generated.
  2. Calculate Your Average Accounts Receivable: This involves finding the average amount of receivables over the same period. To do this, add the value of your accounts receivable at the beginning and end of the period and divide by two. This average is crucial as it considers the fluctuating nature of receivables over time. You can learn more in our guide on how to calculate accounts receivable.
  3. Perform the Calculation: Divide your net credit sales by the average accounts receivable. The formula is as follows: Accounts Receivable Turnover Ratio = Net Credit Sales/Average Accounts Receivable
  4. Interpret the Result: A higher ratio indicates a more efficient collection of receivables, a sign of healthy cash flow. A lower ratio may suggest slower collection and potential cash flow issues, requiring attention.

Calculating your receivables turnover ratio isn’t overly complex, but we want to walk you through a quick example anyway to help you feel more confident doing it yourself. Imagine a company with these figures:

First, find the average accounts receivable through this equation:

(Beginning Accounts Receivable + Ending Accounts Receivable) / 2

Average Accounts Receivable = ($20,000 + $10,000) / 2 = $15,000

From there, you can easily calculate the ART ratio using the equation we shared above. Here’s what we get when we plug in our company’s numbers: 

Accounts Receivable Turnover Ratio = $100,000 / $15,000 ≈ 6.67

So, the ART Ratio for ABC Inc. is approximately 6.67. This means the company collects its receivables about 6.67 times in a year. Is this a good AR turnover ratio, though?

What is a Good Accounts Receivable Turnover Ratio?

Regular tracking of the ART ratio provides insightful trends, helping in making informed decisions on credit policies and cash flow management. 

But now that you have your number, it’s time to get into what you came here for today: what is a good accounts receivable turnover ratio?

Industry Standards and Benchmarks

Unfortunately, the question “what is a good accounts receivable turnover ratio?” doesn’t have a one-size-fits-all answer. It’s often industry-specific. 

Some types of businesses earn cash at the time of sale, while others may get payments periodically over the course of a year. Meanwhile, others may not get paid until a job is complete.

We often see that high-volume, low-margin industries like retail might naturally exhibit a higher ratio due to rapid inventory turnover and shorter credit terms. On the other hand, industries with longer sales cycles, such as manufacturing, might have a lower ratio. 

Therefore, comparing your ratio with industry benchmarks provides a more accurate picture of where your business stands. 

Factors Influencing the Ideal Ratio

What you consider to be a good receivable turnover ratio may not meet the standards of the next company, even within your same industry. It’s important to look at the factors that influence what constitutes a good ART Ratio for your business:

So, What is a Good AR Turnover Ratio?

So, what is a good accounts receivable turnover ratio? As we said earlier, it’s very dependent on your specific businesses. But in general, you need to aim for an ART ratio higher than 1. This means you’re collecting the full AR amount once in a given period.

That being said, some businesses won’t settle for less than 5-7 for their ART, aiming to collect outstanding AR as often as possible in a given period. 

Strategies to Improve Your AR Turnover Ratio

If you discover that you have a good accounts receivable turnover ratio, awesome! If not, what can you do to work towards a good AR turnover ratio? Implementing specific strategies can significantly improve this ratio, ensuring that your business isn't just profitable on paper but also liquid in reality.

Best Practices in Invoicing and Collections

From changing your invoicing standards to re-thinking your invoice late fee wording, there are many ways you can improve your ART ratio:

Leveraging Technology for Efficient Management

It’s common to want to outsource AR when you discover issues like a poor ART ratio. But, accounts receivable management services are too expensive for most small to mid-size businesses, and hiring in-house may not make sense either.

That’s why leveraging technology for more efficient AR management is your best bet. 

Automated invoicing systems utilize software that automatically generates and sends invoices, saving time and reducing human error. You can also consider implementing online payment systems can accelerate the receipt of funds and offer convenience to your customers.

The best accounts receivable software even offers better insights into data that informs your financial decision-making. You can use data analytics to identify trends, such as customers who frequently pay late or the feasibility of a substantial investment by forecasting accounts receivable

That being said, it’s time to streamline your AR processes and say goodbye to the headaches of manually managing accounts receivable. It’s time to simplify things through automation with InvoiceSherpa!

Simplify Your Accounts Receivable Process by Automating With InvoiceSherpa!

InvoiceSherpa is a game-changer for small and medium-sized businesses looking to improve their accounts receivable turnover ratio and overall cash flow. 

This innovative software automates critical aspects of accounts receivable management, such as invoice generation, sending timely reminders, and tracking invoices from creation to payment. 

Its ability to add automatic late fees and offer easy payment options directly from invoices or through a customer portal ensures faster payment collection. 

By reducing the need for manual follow-ups and streamlining the payment process, InvoiceSherpa not only boosts your ART ratio but also enhances your overall financial health, allowing you to focus more on growing your business. 

So, see for yourself why companies like Patagonia, Datanyze, Smartsheet, and many more have trusted their financial management with InvoiceSherpa. You can get a 14-day free trial now!

Bringing Our Conversation on Good Accounts Receivable Turnover Ratio to a Close

We hope you now have a better understanding of not just what a good accounts receivable turnover ratio is, but the insights this ratio tells you and how you can work to improve it within your own organization. 

A good ART Ratio reflects robust credit and collection practices, vital for maintaining healthy cash flow. Embracing best practices in invoicing and collections, coupled with leveraging tools like InvoiceSherpa, can significantly improve this ratio. 

Learn more about the difference between an estimate vs invoice or how to send an invoice to collections in our blog. Otherwise, it’s time to invest in simpler, more streamlined financial management today at InvoiceSherpa. 

Remember, a higher ART Ratio not only signifies effective receivables management but also strengthens the financial backbone of your business, paving the way for sustained growth and stability. So, leverage automation to improve your ART ratio today at InvoiceSherpa!

Posted on December 5, 2023

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