How to Improve Your Accounts Receivable Turnover Ratio

The ratio will alert you to problems with your receivables so you can take action. 

If clients take too long to pay their invoices — or if some of them never pay at all — your company’s cash flow will suffer. Poor cash flow can limit a business’s ability to compete in the marketplace and, in the worst case scenario, force the business to close.

That’s why calculating your accounts receivable turnover ratio can be helpful. It’s a great metric for measuring a company’s ability to turn invoices back into working capital. 

What is an accounts receivable turnover ratio? How is it calculated? 

The accounts receivable turnover ratio shows how often a company is collecting payment on its average receivables during a given period. It’s a measure of how efficiently a company is managing its receivables. 

To find your company’s ratio, divide net credit sales by the average accounts receivable balance. 

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

First, decide whether you want to calculate the ratio for the month, quarter, year or some other time frame. 

To determine the net credit sales, use the amount of sales made on credit during that period, minus any sales allowances or returns. Cash sales aren’t counted because those customers don’t owe any money on those sales. 

To find the average accounts receivable, add the starting balance of your accounts receivable to the ending balance for the period in question. (The time frame should match whatever was used to find the net credit sales.) Then divide by two. 

As an example, let’s say a company made $150,000 in sales last month and had $15,000 in returns. On the first day of the month, it showed a total of $20,000 in receivables on its books. By month’s end, the total was down to $10,000. 

The higher the ratio, the better for the business. It means the company is getting paid faster. A lower ratio could signal there is a problem — either with collections, credit policy or the overall financial health of the company’s clients.

But what counts as a “good” ratio can vary by industry and business. If you calculate your turnover ratio every month, you’ll know if your company’s ability to bring in payments is improving or worsening. You might also compare your numbers to industry averages, if they’re available. 

Strategies for improving your accounts receivable turnover ratio

Bill clients as soon as possible 

The faster you invoice your clients, the faster they can pay you. So send the bill as soon as work is completed or the client accepts delivery. 

Depending on your company’s situation, you might even have the ability to ask for prepayment. 

Make sure your invoices are accurate

If there are errors in your invoices, your clients will ask you to fix the problem — as they should! 

But resolving the matter will delay payment. It’s better to get everything right the first time. 

Communicate your payment terms clearly and early

Let your clients know, early on, when payment will be due so they can plan for that. It can help to give reminders, too: Make sure your terms are prominently displayed on the invoice itself. 

Give your customers multiple ways to pay you

Some clients may be happy with wire transfers and printed checks, but others will prefer online payment, electronic funds transfers and other options.

It’s possible to increase efficiency with customers that need to continue using physical checks, too. Set up a lockbox account to get the money into your accounts more quickly. 

Offer attractive discounts for early payment

“Attractive” is the operative word here. Traditional terms like 2/10 net 30 may not be appealing to every client. Many companies benefit by using a system like dynamic discounting where buyers receive larger discounts if they pay earlier. 

C2FO’s dynamic discounting solution, Early Pay, gives companies greater control over how and when to offer discounts, increasing the odds of getting paid faster. 

Produce an AR aging report

An accounts receivable aging report is a list of overdue payments that categorizes each invoice by how late it is. The report usually groups the invoices by date ranges — one to 30 days late, 31 to 60 days late, and so on. Most aging reports also include a “current” field to show invoices that haven’t passed the deadline yet. 

An aging report can show the overall health of your receivables, so it can take special action as needed, such as tightening its credit policies. The aging report also highlights specific businesses that might require an intervention or should be dropped as customers. 

Invest in healthy client relationships 

Ideally, companies will avoid the need to “fire” a client over chronically late or unpaid invoices. Having clear and open communication can go a long way toward preventing those types of choices. 

For example, a client might have an unexpected financial setback and be unable to pay an invoice on time. If you know that, you can make the terms more flexible or work out some other arrangement. Receiving that heads-up also allows you to adjust your own budget and spending. 

The bottom line on accounts receivable turnover ratios

Cash flow is your company’s lifeblood, so if there is a problem, you must uncover and resolve it quickly. Consulting your accounts receivable turnover ratio can help identify any issues that your company might overlook otherwise. Fortunately, the ratio is relatively easy to calculate. 

If you need help addressing your cash flow problems directly, C2FO offers a range of convenient and affordable solutions for working capital, including our best-in-class Early Pay tool. Learn more about it here.