Accounts receivable (AR) turnover measures how efficiently a business collects credit payments from its customers by showing how many times, on average, the business collects outstanding sales that were made using credit in a given time period.
This figure provides insight into how well a business is managing its credit and collection processes. A higher turnover ratio means the company collects payments quickly, which can be good for cash flow. A lower ratio could signal that customers aren’t paying on time or that credit policies are too lenient. Below, we’ll explain how to calculate AR turnover, common calculation mistakes to avoid, and how to improve your business’s ratio.
What’s in this article?
- What is the formula for accounts receivable turnover?
- How can you interpret AR turnover?
- What are common mistakes when calculating AR turnover?
- How can businesses improve their AR turnover?
What is the formula for accounts receivable turnover?
To calculate AR turnover, divide net credit sales by average accounts receivable:
Accounts Receivable Turnover Ratio = Net Credit Sales ÷ Average Accounts Receivable
Net credit sales: The total sales made on credit minus returns, allowances, and discounts
Average accounts receivable: The beginning accounts receivable plus ending accounts receivable, divided by two
Here’s how you calculate each of the figures that comprise the above formula.
Net credit sales
Net credit sales represent the revenue earned from credit sales after accounting for any deductions. To calculate net credit sales, start with total credit sales and subtract any sales returns, allowances, and discounts.
Net Credit Sales = Total Credit Sales − Sales Returns and Allowances − Sales Discounts
Total credit sales: The total revenue generated from sales made on credit (i.e., not cash sales)
Sales returns and allowances: The amounts credited back to customers for returned goods or price adjustments
Sales discounts: The reductions offered to customers for early payments or other incentives
Average accounts receivable
To calculate average accounts receivable, add the starting and ending accounts receivable figures for a specific period. Then, divide this number in half to get the average. Averaging these two values adjusts for fluctuations that might occur during the period, and it makes your AR turnover calculation more accurate.
Average AR = (Beginning Accounts Receivable + Ending Accounts Receivable) ÷ 2
Beginning accounts receivable: The AR balance at the start of the period
Ending accounts receivable: The AR balance at the end of the period
How can you interpret AR turnover?
The AR turnover ratio tells you how often, in a given period, customers pay off their credit purchases. For a business owner, a lender, or an investor, AR turnover reveals how well a company is managing what it’s owed and answers two key questions:
How reliable is this business at turning sales into cash?
Is there a risk this company is too lax or too aggressive with credit?
A high ratio means cash flow is moving and the business has an effective system for managing credit and collections. It also means operations can keep running and plans for growth can stay on track. But if the ratio is too high, it might mean the company is being too strict with credit, and the business could be missing out on sales because customers find the credit terms inflexible.
A low ratio signals inefficiency or risk. It means cash is sitting in unpaid invoices instead of being put to work. A low ratio could also point to bigger issues, such as a weak collection process or the business extending credit too freely to customers who might not pay at all.
A healthy AR turnover means you’ve struck a balance between keeping cash moving and keeping your customers happy. When determining what a “good” AR turnover ratio is for your business, consider the following factors:
Industry norms: A grocery store will typically have a higher turnover than a furniture company, because customers pay for groceries immediately or within days, while big-ticket items such as furniture are often purchased with extended credit terms.
Trends over time: If your ratio starts dropping, that can be a warning signal. Maybe your customers are struggling financially, or your collection process is slipping. If your ratio is improving, your efforts to get paid faster might be working.
Seasonal patterns: Businesses that rely on sales cycles—such as clothing retailers around the holidays—might see an AR spike during busy seasons. Analyzing the ratio during those peak times might not provide the full picture.
What are common mistakes when calculating AR turnover?
Small mistakes in calculating accounts receivable turnover, such as forgetting returns or using mismatched periods, can give a skewed picture of how well a business is collecting its money. When making decisions based on those numbers—whether it’s for cash flow planning, adjusting credit policies, or building investor confidence—accuracy is important.
Here are some common mistakes to avoid when making these calculations.
Including cash sales: The accounts receivable turnover ratio is about credit sales, not total sales. Including cash sales inflates the net credit sales, and it makes the turnover ratio look higher than it actually is.
Not accounting for returns or discounts: If you forget to subtract returns, allowances, and discounts from credit sales, you’ll overstate the amount of money customers owe and make the turnover look artificially high.
Using the wrong AR figure: One potential mistake is to just use the ending AR balance instead of calculating the average accounts receivable. This can distort the ratio, especially if receivables saw an unusual spike or dip near the end of the period. Averaging smooths out fluctuations, and it provides a more realistic view of performance.
Forgetting to match periods: The credit sales you use to calculate AR turnover need to be from the same time frame as the receivables you’re analyzing. For example, if you’re using annual net credit sales, you need to use the average AR for the same 12-month period. Using mismatched periods can significantly distort your ratio.
Overlooking write-offs: When accounts are deemed uncollectible and written off, they should no longer be included in AR. If you do not remove these bad debts, your average AR will be inflated, which drags down the turnover ratio. These write-offs can also indicate a bigger issue—are you extending credit to the wrong customers?
Not adjusting for seasonality: If your business has seasonal sales, taking your numbers at face value can be misleading. A massive AR balance at the end of the year doesn’t necessarily mean your collections are fatally flawed; it could just reflect the season’s surge. To avoid this pitfall, use trailing averages or analyze turnover over shorter periods (e.g., quarterly) to account for those seasonal trends.
Ignoring industry benchmarks: A turnover ratio that looks low on paper might be normal in certain industries. For instance, a construction company might take longer to collect because projects involve milestones and extended terms; meanwhile, a wholesale supplier might see faster collection cycles because of tight, short-term credit terms. Compare your ratio to industry standards or similar businesses so you have the appropriate context.
Neglecting inconsistent policies: If your company’s credit policies changed during the year (e.g., longer payment terms), it could complicate the results. You might see a lower turnover ratio, but that might reflect the new policies as opposed to worsening conditions.
How can businesses improve their AR turnover?
To improve your ratio, you’ll need to encourage customers to pay faster without pushing them away. It’s a balancing act: you want cash flow moving, but you also want to maintain trust and keep new sales coming in. Here are some practical ways businesses can improve their AR turnover.
Set clear payment terms: If customers aren’t sure when they’re supposed to pay, or if your terms are too relaxed, payments will lag. Spell out the payment terms up front and make sure customers understand exactly when payment is due.
Make it easy to pay: Remove roadblocks by offering multiple payment options, including credit cards, bank transfers, and mobile payments. Use tools that send automated invoices and reminders. You want to make your customer feel that paying you is as easy as clicking a button.
Invoice promptly: The sooner you send invoices, the sooner you get paid. Waiting a week or two to bill a customer delays the entire process. Automate your invoicing, so you can send invoices immediately after delivering the product or service. Additionally, include a due date on your invoices rather than just a term such as “net 30.”
Incentivize early payment: Reward customers for paying early. Offering a small discount, such as 2% off if paid within 10 days, can be enough to get invoices settled quickly.
Be firm about late payments: Chasing payments can be tedious, but customers need to know you’re serious about collecting. Establish a process for late payments, such as sending polite reminders a few days before and after the due date and introducing late fees for overdue invoices. Make sure customers are aware of your process, so there are no surprises. For long-overdue accounts, consider stopping work or putting future orders on hold until payment comes through.
Screen customers before offering credit: Before extending credit, check a potential customer’s payment history, credit score, or references. Start small if they’re a new customer or have limited credit history. It’s better to decline on a sale to a higher-risk customer than to lose out if they don’t pay.
Follow up, but automate the heavy lifting: Collections take time, and it’s easy to neglect follow-ups when you’re busy. Use accounting software that sends automatic reminders before, on, and after the due date and personally follow up about invoices that are particularly large or late. A simple email reminder or phone call can nudge customers who forgot or overlooked their payment.
Monitor and analyze your AR regularly: Check your AR aging report continually to monitor overdue invoices, and look for patterns. Are certain customers always late? Do some industries or seasons often lead to delayed payments? Use this information to adjust your credit terms, flag risky accounts, or increase collection efforts where needed.
Consider factoring receivables: If cash on hand is a pressing concern, you can sell your unpaid invoices to a factoring company at a discount. The factoring company will give you cash up front and take over your collections. You lose a percentage of the invoice, and you might risk ostracizing your customers by handing them off, but it can be a lifeline if you need cash to keep operating.
The content in this article is for general information and education purposes only and should not be construed as legal or tax advice. Stripe does not warrant or guarantee the accurateness, completeness, adequacy, or currency of the information in the article. You should seek the advice of a competent attorney or accountant licensed to practice in your jurisdiction for advice on your particular situation.