A financial indicator called the trade receivables turnover ratio is used to assess how successfully a business collects payment from its clients for credit sales.
The effectiveness of a company’s credit and collection practices is calculated by the trade receivables turnover ratio. It is figured up by dividing net credit sales by the average accounts receivable during a given time frame.
The Trade Receivables Turnover Ratio or Accounts Turnover Ratio measures how frequently a company converts its accounts receivable into cash over a given time period. A lower ratio shows that a company is taking longer to collect its receivables, which could be the cause of concern, while a higher ratio shows that a company is collecting its receivables more rapidly, which is typically considered a positive indicator.
Net Credit Sales and Average Accounts Receivables can be defined as:
Net Credit Sales: These are the total sales a business made on credit over a certain time period less any returns or discounts that were offered. (Net Credit Sales = Total Sales – Cash Sales)
Average Accounts Receivable: It is the term used to describe the typical sum of money that clients owe a business for products or services they purchased on credit. It is determined by multiplying the accounts receivable beginning and ending balances by two.
Formula:
Significance:
The Trade Receivables Turnover Ratio is a crucial indicator of how well a company’s credit and collection strategies are working. A greater ratio shows that a business is producing cash flow more swiftly by collecting receivables more quickly. A smaller ratio, on the other hand, shows that a business is taking longer to collect its receivables, which can have a detrimental effect on working capital and cash flow.
Illustration 1:
Calculate Trade Receivable Turnover Ratio from the following data:
Solution:
Credit Revenue from Operations = Total Revenue – Cash Revenue
Credit Revenue from Operations = ₹4,00,000 – ₹80,000
Credit Revenue from Operations or Net Credit Sales = ₹3,20,000
Average Trade Receivables =
Average Trade Receivables =
Average Trade Receivables = ₹80,000
Trade Receivables Turnover Ratio = 4 Times
Illustration 2:
Calculate Debtor Turnover Ratio from the following information:
- Total revenue from operations: ₹10,40,000
- Cash revenue from operations is 30% of credit revenue from operations
- Closing Debtors: ₹1,60,000
- Opening debtors are
of closing debtors
Solution:
Computation of Credit Revenue from Operations:
Let Credit Revenue from Operations = ₹100
Therefore, Cash Revenue from Operations = ₹30
and Total Revenue from Operation = ₹130
Therefore, Net Credit Revenue from Operation =
Computation of Average Debtors:
Closing Debtors = ₹1,60,000
Opening Debtors =
Average Debtors =
Average Debtors =
Debtor Turnover Ratio = 5.71 Times