Receivables turnover is an important activity ratio, and provides a measure of how effectively a business is managing its receivables.
The receivables turnover ratio measures the number of times the company collected its receivables during a specified period.
For example, a receivables turnover ratio of 10 means that the receivables have been collected 10 times in the specified period, usually a year. A variant of receivables turnover is Days of Sales Outstanding (DSO) or average collection period. A DSO of 30 means that on average the company had 30 days worth of sales outstanding (yet to be collected).
Revenue is taken from the Income Statement and Receivables are taken from the Balance Sheet. Since the balance sheet tells the financial condition of a company at the end of the period, we take Average receivables for the year in our calculation. For revenue we are generally concerned about the credit sales. So, the analyst may have to exclude cash sales from the total sales figure.
365 is the most commonly used day count convention however some analysts may prefer to use 360 days.
Assume that the credit sales for a company for the previous year was $100,000 and the beginning and ending receivables for the year were 8,000 and 12,000.
This means that the company collected its receivables 10 times during the year.
This means that on average the company had 36.5 days of sales outstanding at any time.
Note that if the analyst is particularly interested in how much receivables were outstanding at the end of the financial year, then he will use the closing receivables for the above calculation.
These ratios are an indicator of how fast or slow the company is collecting its receivables.
The ratio is compared with others in the industry to measure the performance.
A high receivables turnover ratio (or a low DSO) generally indicates that the company has good collection. It can also mean that the company has very strict collection policy, which could actually impact the revenues.
A low receivables turnover ratio (or a high DSO), compared to its peers, could indicate that the company is unable to collect its receivables and that it has a poor collection policy/procedure.