If Sales Is Not Your Problem, It's Probably Accounts Receivable

Have you ever worked so hard in your business, sold out, but are still struggling?

You know the money is coming, but you can't get it on time enough to meet your expenses. As it slowly trickles in, you feel like you are drowning in unexpected obligations and struggling to keep your head above water.

Sales is not your problem. Accounts receivable is.

Luckily for you, this is a problem that business owners have been facing since the beginning. And once you understand the importance of it and how to measure it using the turnover ratio, it becomes much easier to manage.

Accountants use the Turnover ratio to quantify and measure how you collect money from your customers. Because it's a ratio, the numbers can tell you when you are getting better or worse at managing it.

As you master your accounts receivable, you will have the working capital to fund innovation, invest in growth, and cover unexpected expenses.

The accounts receivable turnover ratio establishes and improves the efficiency of your revenue collection process over some time.

In simple terms, it ensures that you are collecting what your customers own you from credit purchases promptly, which allows you to make the most use of the money.

How do you Calculate this Ratio?

This ratio is done based on the following formula.

Net Credit Sales / Average Accounts Receivable= Accounts Receivable Turn Over

Your net Credit Sales are all the sales you made on credit, less any returns or sales allowances made.

Your Average Accounts receivable is the (Beginning Accounts Receivable+Ending Accounts Receivable)/2.

When you have your Turnover ratio, you can convert it to days by diving 365/ ART to find out how long it takes your business to collect from its customers.

Let's do an example together.

Let's say you are a business that makes and sells soap. In 2022, you sold $ 3,000 of soap to your customers on credit. You had a return of $50 worth of product.

Meaning your Net Sales would be $3000-$50= $2995

The starting Accounts Receivable in 2022 were $200, and the ending was $300, meaning you have an average of ($200+$300)/2=$250

When you plug these values into the formula, you have a turnover ratio of 11.98 ($2995/$250=11.98).

This 11.98 means you collected your average accounts receivable from your customers 11.98 times yearly.

Based on the formula (365/11.98=30.46), your average customer takes approximately 30 days to pay you for their credit purchase.

Is it Bad or Good?

Your accounts receivable turnover ratio is more complex than being bad or good. Instead, you must first review your policies. Are the days it takes you to collect in line with the credit policy you created?

Do they align with when you must pay your debtors, or is it taking longer to collect from your customers?

What is the Industry Average?

Research and find out the average for other businesses in your industry. It's good to see whether your ratio is higher or lower and adjust your policies to meet industry standards.

Getting paid promptly and regularly gives you access to the cash flow you need to grow and innovate your business. It also helps you to remain competitive in your industry.

Ensure your ratio aligns with your company's needs and goals, and then you will have the money you need when you need it.

The Challenge
Find out your industry's Accounts Receivable Ratio, then check your business's against the industry average this week. Decide if you need to make a change.