Managing accounts receivable is one of the biggest pains in any business, let alone managing the AR turnover. But despite it’s difficulty, it is also an extremely important part of managing any business and keeping cash flow headed in the right direction. Continue reading to find out how you can calculate and manage accounts receivable turnover ratios.
What is accounts receivable turnover?
Accounts receivable turnover measures how efficiently your company is issuing credit and collecting AR from its client. Understanding your turnover ratio will help you determine how efficiently your company is issuing and collection credit to its clients.
How to calculate accounts receivable turnover.
So, how do we calculate accounts receivable turnover ratio? To calculate the ar turnover ratio you need the net credit sales and the average account receivable.
Let’s assume you’ve made $100,000 of sales issued on credit during the year. The net credit sales is $100,000.
Now, let’s say, your accounts receivable at the beginning of the year was $45,000 and at the end of the year it was $35,000. To calculate the average account receivable you’ll need to add the average AR during the beginning of the year and at the end of the year and divide by two.
Here, the average account receivable will be $40,000.
AR Turnover Formula & Calculator
AR Turnover Ratio = Net Credit Sales / Average Accounts Receivable
What is a good accounts receivable turnover ratio?
The standard of a good turnover rate can differ slightly based on your business. Generally a higher number is better because it indicates that you’re probably able to invoice and collect from your clients on a regular and timely basis. It could also be the case for operations that are largely cash based.
A high AR turnover ratio is good but it can also be too high. This could either mean that your policies are too strict which could result in bad customer relationships or your credit sales are too low and you need to increase sales.
A low account receivable turnover ratio indicates that you aren’t collecting your account receivable turnover as efficiently as you are issuing credit to your clients. You should revisit your payment policies, evaluate your days sales outstanding (DSO) or their business problems like failing to provide satisfactory service or product that might be bringing your ratio down.
How to improve your accounts receivable turnover
Let’s look at some effective ways you can improve your accounts receivable turnover without ruining your customer relationship.
Make sure both you and your client have clearly communicated the payment expectations. Put it in your contract when and how they will be invoiced. How soon after your invoice was issued do you expect to be paid? Another important thing to know is who processes the payments? You may have an amazing relationship with the marketing director who approved your services, but she is not likely to be the one who writes the checks. Find out who that is and communicate with them directly for faster payment processing.
Offer a discount
Many people will pay early if they have an incentive to do so. One or two percent of the total may seem like a lot to give up, but what it will save you both time and money in the long run. You’ll have clients who frequently pay in advance to take advantage of the discount and in turn increase your turnover ratio. More cash in the bank means you can focus on growing your business without having to stress over money you’ve already earned!
Some people see a deadline 30 days in the future and forget about it. It’s not on their radar yet but a friendly reminder can bring the deadline to top-of-mind closer to the due date. Set up an automatic reminder a few days before the invoice is due so you don’t have to stress over keeping track of each and every invoice. It also gives you another chance to communicate with your client. Maybe your reminder has a link to your latest blog post or a notice about an upcoming special sale. Your reminder serves a dual purpose of giving you the chance to let your customers know what’s going on in your business in addition to reminding them that it’s time to pay.
Add a Late Fee
If a friendly early bird discount isn’t efficient set up late fees. The late fee works on the same philosophy as the discount for early payment. Everyone wants to avoid extra expenses. If your customer knows you will add a fee to a late payment, he or she has an extra incentive to get your money to you on time.
Make It Easy to Pay
When you have bills to pay, you want it to be as easy as possible. If it requires your clients to login to multiple platforms to make the payment there is a high chance that it will be delayed when they have more urgent tasks. If you want to get to the front of your customer’s bill pay line, make it painless. As easy as clicking a link. Integrate a direct payment method on your electronic invoice so all they have to do is click a link and make the payment. If your payment software allows your customer to safely store his payment data it’s easy as one two three.
InvoiceSherpa has all these features at your fingertips. With customizable email templates, you can easily remind your customers when it’s time to pay. The direct online payment link on the invoice makes it easy. You can also set up thank you emails that let your customer know you received the payment. And it gives you another opportunity to let them know how much you appreciate their business. Money in the bank beats money on your balance sheet every time.