Accounts receivable turnover ratio: the formula and what good looks like

The ratio compares the money sitting in accounts receivable with how much you sell on credit. Think of it as how many times that balance is collected and refilled during the year. A ratio of 12 means the balance turns over roughly once a month. A ratio of 4 means it turns over roughly once a quarter, so the typical invoice waits about three months to be paid.

In the UK you will also see it called the debtor turnover ratio or receivables turnover, and the days version is often called debtor days or the debtor collection period.

AR turnover ratio = Net credit sales ÷ Average accounts receivable

Each part needs a little care.

Net credit sales are sales made on invoice, less credit notes, refunds and allowances. Leave out sales paid up front by card or cash, because they never became receivables. For most business-to-business service companies nearly everything is invoiced, so net credit sales will be close to total revenue.

Average accounts receivable is usually the opening balance plus the closing balance, divided by two:

Average AR = (Opening AR + Closing AR) ÷ 2

An average stops one unusual day, like a large project invoiced on the last day of the year, from skewing the result. If balances swing a lot, average the twelve month-end balances instead.

Use the same period for both figures. A year of sales against one month's average balance gives a meaningless number.

Say a consultancy has these figures for its financial year:

• Net credit sales: $1,200,000
• Accounts receivable at the start of the year: $140,000
• Accounts receivable at the end of the year: $100,000

First the average balance:

($140,000 + $100,000) ÷ 2 = $120,000

Then the ratio:

$1,200,000 ÷ $120,000 = 10

The consultancy collects its average receivables balance ten times a year.

A ratio of 10 is hard to act on. Days are easier. Divide the number of days in the period by the ratio:

Average collection period = 365 ÷ AR turnover ratio

For the consultancy:

365 ÷ 10 = 36.5 days

On average, an invoice takes about 36 or 37 days to be paid. If its customers are on Net 30, they are paying about a week late on average.

This days figure is closely related to days sales outstanding. Both measure how long sales sit unpaid, and when they use the same figures they give the same answer. Pick one, calculate it the same way every time, and watch the trend.

Measuring a quarter or a month

You do not have to wait for year end. Use the sales and average balance for the quarter, then divide the days in that quarter by the result.

Say a business has $300,000 of net credit sales in a 90-day quarter and an average receivables balance of $150,000. The quarterly ratio is 2. The collection period is 90 ÷ 2, which is 45 days. If you want to compare a quarterly ratio with an annual one, multiply it by 365 and divide by the days in the quarter: 2 × 365 ÷ 90 is about 8.1.

Start with your terms, not an industry table. The ratio you would get if customers paid exactly on time is a sensible target:

These are arithmetic, not benchmarks: 365 divided by the number of days. Real results sit a little below them, because some invoices are always a few days late.

Then compare against yourself. A ratio that drops from 10 to 8 over two quarters means the average invoice now takes about 46 days instead of 37. That is worth finding out about whatever the industry average is.

A high ratio is generally good, but it can also mean your terms are tighter than customers in your market expect, or that you take a lot of payment up front. A low ratio usually means customers pay late, invoices are stuck, or your terms have drifted longer than you realized. Our guide to Net 30 payment terms covers setting terms so they hold.

The ratio is an average, and averages hide things.

• One large late invoice. A single $60,000 invoice that is four months overdue can drag the ratio down while every other customer pays on time.
• Seasonal sales. If you invoice heavily in the last month of the year, the closing balance is high and the ratio looks worse than collections really are.
• Mixed terms. A customer base split between Net 15 and Net 60 will produce a ratio that matches neither.
• Cash sales included. Counting up-front payments as credit sales makes the ratio look better than it is.
• Bad debts. Writing off old invoices lowers receivables and lifts the ratio, without a cent being collected.

This is why the ratio is a starting point. An accounts receivable aging report shows the invoices behind it: who owes what, and for how long.

Track the ratio monthly or quarterly in a spreadsheet. A layout you can copy:

Period:                        [Month or quarter]
Days in period:                [30, 31, 90 or 365]
Net credit sales:              [Amount]
Opening accounts receivable:   [Amount]
Closing accounts receivable:   [Amount]
Average accounts receivable:   [(Opening + Closing) / 2]
AR turnover ratio:             [Net credit sales / Average AR]
Average collection period:     [Days in period / AR turnover ratio]
Usual payment terms (days):    [e.g. 30]
Days beyond terms:             [Collection period - Terms]
Largest overdue invoices:      [Customer, amount, days overdue]

"Days beyond terms" is the line to explain to a partner. The largest overdue invoices tell you where to start.

You do not improve the ratio directly. You get individual invoices paid sooner, and the ratio follows.

1. Invoice the day the work is done. Payment terms only start once the invoice is dated and sent.
2. Get the invoice right first time. A missing PO number, the wrong legal entity or the wrong contact can hold an invoice for weeks.
3. Remind before the due date, follow up the day after. A short note a few days early catches an invoice that never reached accounts payable.
4. Find out why each overdue invoice is unpaid. A reminder does not fix a missing approval. Our guide to collecting unpaid invoices works through the common reasons.
5. Track promised dates. When a customer says "we'll pay on the 15th", write it down and follow up on the 16th if nothing arrives.
6. Resolve disputes quickly. Give each query an owner. See our guide to handling an invoice dispute.
7. Review terms for repeat late payers. A customer who always pays at 70 days on Net 30 may need a deposit or staged billing next time. An early payment discount is another option, but work out what it costs first.

Our collections email sequence sets out one from first reminder to final notice, including how to reply to each kind of answer.