Video Transcript: Accounts Receivable Turnover
Hello and welcome back, and now we're going to discuss the accounts receivable turnover. Accounts receivable turnover is the number of times per year that the average amount of accounts receivable is collected. To calculate this ratio, divide the net credit sales, or net sales, by the average net accounts receivable. And here you can see you're dividing your net your net sales, by your average net accounts receivable. To get your accounts receivable turnover, ideally, an average net accounts receivable should represent weekly or monthly averages often, however, beginning and end of year averages are the only amounts available to users outside the company, although analysts shouldn't use net credit sales frequently, net credit sales are not known to those outside the company. Instead, they use the net sales in the numerator generally, the fast, the faster firms collect accounts receivable, the better a company with a high account receivable turnover ties up a small proportion of its funds in accounts receivable than a company with a lower turnover, both the company's credit terms and collection policies affect turnover. For instance, a company with credit terms of two to 2% the terms of 2 10/30 represent 2% of paid in 10 days, and the net balance is paid in 30 days. That's what those numbers represent. And they would expect a higher turnover than a company with terms of net 60 days. And that's obviously because 30 days you're paying quicker than 60 days. Also a company that aggressively pursues overdue accounts receivable has a higher turnover of accounts receivable than one that does not for example, we calculate these accounts receivable turnovers for the following hypothetical companies. So Abercrombie Finch has an 88.43 turnover, whereas the Limited has a 10% turnover. And how you calculate the accounts receivable, the number of days per year divided by the accounts receivable turnover will give you the number of days sales per accounts receivable. This ratio measures the average liquidity of accounts receivable and gives an indication of the quality. The faster a firm collects receivables, the more liquid they are, and the higher their quality, the longer accounts receivable remain outstanding, the greater the probability they never will be collected. As the time period increases, so does the probability that customers will declare bankruptcy or go out of business. Based on 365 days, we calculated the number of days sales for each of these hypothetical companies. So for Abercrombie and Finch, the number of days the sales is four, four days, and the limited, excuse me, was 36 and a half days. These companies have collection periods ranging from 4.1 days to 300 to 36 and a half days, assuming credit terms of 2% at 10 days and net 30 would expect the average collection period to be under 30 days. If customers do not pay within 10 days and take the discount offered, they incur an annual interest rate of 36 and a half percent on these funds. They lose a 2% discount and get to use the funds another 20 days, which is the equivalent to an annual rate of 36 and a half percent. Having studied receivables and payables in this chapter, you will study plan assets in the next chapter. These long term assets include land
depreciation assets such as buildings and machinery and equipment. Thank you.