How Can You Improve Your Account Receivable Turnover Ratio?

“Never take your eyes off the cash flow because it’s the lifeblood of business.” — Richard Branson. Positive cash flow is the dream of every business. The primary reason behind positive cash flow is a positive Account Receivable Turnover ratio, and the positive turnover ratio is the result of valid credit policies and processes. 

If your debtors pay you timely, you will likely never run out of cash. Moreover, it helps you understand how quickly you get paid so that you can pay for your company expenses and invest strategically on time. 

These are the core reasons accountants always focus on the Account Receivable Turnover ratio. Before dwelling on improving your account receivable turnover ratio, let’s understand the account receivable ratio and its calculation.

What is Account Receivable Turnover Ratio?

The account turnover ratio or receivables turnover measures the number of times you collect your average accounts receivable. It shows how efficiently you manage revenue. In simple words, receivable turnover demonstrates how quickly you can convert your AR into cash in a given period. A high ratio specifies that your company’s collections are effective with high-quality customers who pay bills on time. In contrast, a low ratio shows the inefficient collection process with unfavourable credit policies and non-credit-worthy customers. 

How to calculate Account Receivable Turnover Ratio?

The receivable turnover ratio is the ratio of net credit sales and the average accounts receivable. It would help if you first calculated the nominator (net credit sales) and denominator (average accounts receivable).  The following are the steps to calculate the account receivable turnover ratio: 

• Determine Net Credit Sales

Net credit sales are when you and your customer agree to pay the price at a later collection date. The formula for net credit sales is pretty simple, you need to subtract the sales returns and allowances from the sales on credit. One thing you must always consider is using a consistent time frame while calculating net credit sales, for instance, calculating net credit sales for the fourth quarter only. However, future returns should be accounted for in the fourth quarter’s net credit sales. 

•   Average Accounts Receivable

Account receivable is the amount owed to you by your customers. Start by taking the average of your account receivables’ beginning and ending balances. Then divide the sum of the opening balance and closing balance of the account receivable of a period by two. With modern account receivable software, you don’t need to sit at the table with calculators and excel sheets. Now you can quickly get the average account receivables on the receivable software at the end of each day.  

• Use the Receivable Turnover Ratio

Put the above-found results, i,e, net credit sales and average accounts receivable, in the formula below to get the receivable ratio.

Account Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Now that you know the basics of the receivable turnover ratio, let’s learn how to improve it.

Every industry has its own average receivable turnover ratio. For instance, in Q2 2022, the financial sector’s AR turnover ratio was 0.41, whereas the service sector had 7.31. You can check out your industry’s average receivable turnover ratio also. But remember, it doesn’t matter if your AR turnover ratio matches the industry standard; there is always scope for improvement. So learn what you can do to improve your account receivable turnover ratio.  

How can you improve your Account Receivable Turnover Ratio?

• Invoice Properly

The crystal-clear invoices will help your customers to pay their bills timely. You will get paid faster if you send your bills promptly with clear payment terms. Mention the payment duration and late payment fees after a specific date. Usually, the business owner keeps the late fee as a percentage of the original bill. Moreover, you can set credit limits or offer discounts on early payments (such as within a week of the issue of the bill). 

• Focus on Building Good Customer Relationships

Good customer relationship is one of the common ways of improving your account receivable turnover ratio. If you have built a good relationship with your customer, you will get paid faster, and converting receivables to cash will also become more manageable. Moreover, it’s well-established that customers are always happy to pay for a great customer experience. Give a friendly phone call or email to check on your customer and try to understand if they have genuine reasons for late payments. 

• Following Up

Sending friendly payment reminders 10 days before the due date will give the customer enough time to clear the bill or arrange the money. In case of non-payment of the invoice, follow up with your clients. You can send professional reminders to clients as they don’t wish to spend extra money due to late payments. 

• Avoid Common Delays

Be aware of common invoice delays and avoid them. For instance, the client making the deal may need to be clearing the payments. So always know who should receive it. Plus, state the payment terms verbally and in written format before starting a project, and don’t send invoices on inconvenient days. 

• Cloud-based Software

Invoices are filled with valuable data, and any error in the invoices can lead to financial loss. That’s why you should consider using cloud-based account receivable software. You can easily keep track of all invoices by automating the invoice management system. Besides reducing the human error of missing an invoice or inaccuracy, it gives you insightful reports with one click. 

Ensure that every step of invoicing and receiving payment process is correct. Moreover, be aware of the updates in your invoice management system. Plus, if some invoices are clearing out, offer discounts on early payments, late fees for overdue payments, etc. 

CONCLUSION

Improving the account receivable turnover ratio is a complex and lengthy process. Putting your accounting team to this task is a non-optimal use of your team’s talent. A more cost and time-effective method to improve the receivable turnover ratio is outsourcing receivable turnover management. 

At SKB Accounting, using QuickBooks– the all-rounder accounting receivable software- we manage your receivables so that you run behind your business goals, not the customers. Besides this, we regularly audit your account receivables and try to eliminate maximum bad debts. We help you make money by ensuring you get timely payments. Want to have a quick call to learn how we will provide a positive receivable turnover ratio for your company, contact SKB Accounting now.