Accounts receivable turnover is a financial problem that many small businesses run into because owners often extend credit to clients, leading to a delay in payment.
Accounting Tools defines accounts receivable turnover ratio (ART) as the number of times per year that a business collects its average accounts receivable.
With that being said, is calculating accounts receivable turnover and working to improve it really that vital to your company?
Increasing your accounts receivable turnover ratio can be a challenge, but if you can accomplish it your organization will operate more efficiently due to a smoother cash flow. In this article, we’ll show you why accounts receivable turnover matters. We also provide you with 10 best practices to increase your accounts receivable turnover (ART) ratio this year.
Why Your Accounts Receivable Turnover Matters
In addition to calculating the likelihood and speed of the payments you’ll receive, the ratio can help you determine how well your company is handling credit policy and practices and managing customer debt.
A high ratio means good things for your company:
- You receive payment for debts, which increases cash flow.
- Your customers are paying off debt quickly, freeing up credit lines for future purchases.
- You’re extending credit to the right kinds of customers, meaning you don’t take on as much bad debt.
- Your collections methods are effective.
A low ratio means that your company has areas that can be improved:
- Collections policies may not be effective.
- Your customers may be struggling to make payments, making it less likely that they will make future purchases.
- Bad or uncollectible debt is hurting cash flow.
- You are giving credit too leniently.
By tracking accounts receivable, you can find where your business has opportunities to improve both its policies and the bottom line.
Managing accounts receivable is one of the biggest pains in any business, let alone managing the turnover. But despite its difficulty, it’s also an extremely important part of managing any business and keeping cash flow headed in the right direction. Next, we will give you 10 of the best practices to improve your accounts receivable turnover to help maximize your organization’s profits.
Accounts Receivable Turnover Best Practice #1: Know Your A/R Turnover Ratio
When thinking about trying to improve or manage accounts receivable turnover you need to know where you stand. The easiest way to do this is using a handy ratio that will tell you how quickly you’re collecting your total balance of accounts receivable in any given period.
Your ART ratio is calculated by adding together beginning and ending accounts receivable to arrive at the average accounts receivable for the measurement period, and divide into the net credit sales for the year.
How is Accounts Receivable Turnover Calculated?
You can easily calculate your business’ accounts receivable turnover ratio by using the following formula:
Net credit sales ⁄ average accounts receivable
Lower numbers equal lower collections ratios, which means your business isn’t getting paid and your business is incurring debt. Higher numbers equal higher collections ratios, which means you are receiving payments and increasing cash flow.
Let’s look at an example: Your company saw $200,000 in net credit sales for the year and average receivables of $50,000. By applying the above formula, your company’s accounts receivable turnover ratio would be 4 (200,000 / 50,000 = 4).
This means that your company is collecting receivables only 4 times a year or it is roughly taking your company 91 days to collect its debt (365 days a year / 4 = 91.25 days). For many companies, they may not see this as a big deal but…
Accounts Receivable Turnover Best Practice #2: Create an A/R Aging Report
After determining your ART ratio, your next step to take in your collections effort is to determine the current payment status of all your accounts receivable.
This is done by creating an accounts receivable (A/R) aging report, which will track and measure the payment status of all your customers.
Accounts are broken out by the number of days since the invoice was issued (such as 0-30 days, 31-60, 61-90 days, and beyond 90 days) and the amounts due. This way, you can spot potential collection problems early, before accounts become significantly past due. This allows your AR department to focus your collection efforts more efficiently.
Accounts Receivable Turnover Best Practice #3: Improve Collections Efficiency
This best practice is no secret—if you can find a way to make it easier for you to collect on what is owed, your ART ratio will increase.
The best way to achieve this is to make it as easy as possible for your customer to pay on time. Some ways you can achieve this is by implementing a lockbox service, pre-authorized checks, utilizing an automatic clearinghouse, or purchasing a cloud-based A/R management solution.
First, with a lockbox, customers will have a universal location where they can drop off their payments.
Second, pre-authorized checks allow your business to draw payments from customer accounts regularly.
Third, an automatic clearinghouse transfers funds from your customer to your business electronically.
Finally, purchasing a cloud-based accounts receivable solution makes it easier for you to track all of this activity from anywhere and at any time.
Accounts Receivable Turnover Best Practice #4: Tightening Up Turnover and Cash Flow
When you find yourself short on cash and sales aren’t to blame, the next stop is generally your accounts receivable turnover. You need to make sure that when you sell a product you deliver it quickly and then get paid quickly.
This comes down to an efficient and well-run accounts receivable flow.
Start with creating and sending invoices. Make sure your invoices are being created as soon as the product is delivered and even being included when delivery takes place. This can also work for a service by simply rendering the invoice at the time of service delivery.
Accounts Receivable Turnover Best Practice #5: Review Your Credit Terms
Think about your current credit terms—it might be time to change them for some or all of your customers.
Reduce your payment terms to 10 days or two weeks, depending on your customers. Extend longer terms to customers who must first sell what they buy from you before they can pay you if they are larger, regular customers. Reduce payment terms to customers who you know have money to pay their bills and won’t be inconvenienced by paying earlier.
Reviewing your credit terms includes reducing the time frame a customer has to pay a bill, but it should also entail sending invoices out as soon as possible, and monitoring your Accounts Receivable Turnover ratio on a consistent basis.
Additionally, look into industry averages. It’s possible that the reason you are having a hard time collecting what is owed to you is due to not understanding how your industry normally collects.
Finally, you might frankly want to discontinue selling on credit to customers who regularly pay late. Calculate the interest you pay on materials or goods you sell to late-paying customers and subtract it from your profits from those sales to determine if you can afford to keep these customers.
Accounts Receivable Turnover Best Practice #6: Implement Recommended Cash Management Tools
Banks offer a wide range of cash management services that can help you improve collections and better manage your cash flow cycle.
One of these is a wholesale lockbox, in which clients mail checks to a special post office box monitored by the bank, which collects and deposits them immediately.
Another one is electronic payments made via the Automated Clearing House (ACH), which eliminates “the check is in the mail” syndrome altogether.
Accounts Receivable Turnover Best Practice #7: Offer Incentives
Incentives can be a useful strategy when trying to increase your accounts receivable turnover ratio. Give your customers an incentive to pay their bill early.
These incentives don’t have to be overly costly—you could offer them small discounts, free shipping or delivery, and small gifts.
These incentives would most likely be enough to motivate the majority of your customers to pay you sooner. Incentives increase the likelihood of your customers paying you, which results in higher accounts receivable turnover, better cash flow, and a more efficient business.
Accounts Receivable Turnover Best Practice #8: Automate and Streamline
According to Paystream Advisors, companies who use traditional collection techniques spend 15% of their time preparing for calls and another 15% prioritizing.
In total, that is 30% of your time being spent on activities other than soliciting customers for payment.
Accounts Receivable Turnover Best Practice #9: Remind Clients. Then Remind Them Again.
Staying on top of invoices from the very beginning is the key to success when handling accounts receivable turnover.
If you send a notice as soon as an invoice has been cut, followed up by another notice a few days before the invoice is due you greatly increase your odds of getting paid faster. You will almost inevitably rise higher on the list of invoices waiting to be paid.
These reminders can be friendly and helpful ways for your clients to remember you. No one wants to be past due on a bill and these reminders help your clients remember before you have to start sending them past due notices.
Increasing your accounts receivable turnover will help your business run more efficiently and you can enjoy getting paid faster.
The most effective way to accomplish this is through accounts receivable automation. Automate invoice generation and delivery to get your invoices into your customers’ hands quicker. Your customers want to pay you on time, so make it easy for them. Learn more today about DocLib’s accounts receivable automation solution and let us help you drastically improve your accounts receivable turnover.