Debtors Turnover Ratio | Accounts Receivable Turnover Ratio

Debtors Turnover Ratio | Accounts Receivable Turnover Ratio:

A concern may sell goods on cash as well as on credit. Credit is one of the important elements of sales promotion. The volume of sales can be increased by following a liberal credit policy.

The effect of a liberal credit policy may result in tying up substantial funds of a firm in the form of trade debtors (or receivables). Trade debtors are expected to be converted into cash within a short period of time and are included in current assets. Hence, the liquidity position of concern to pay its short term obligations in time depends upon the quality of its trade debtors.

Definition:

Debtors turnover ratio or accounts receivable turnover ratio  indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year.

Debtors Turnover Ratio Formula:

Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors

The two basic components of accounts receivable turnover ratio are net credit annual sales and average trade debtors. The trade debtors for the purpose of this ratio include the amount of Trade Debtors & Bills Receivables. The average receivables are found by adding the opening receivables and closing balance of receivables and dividing the total by two. It should be noted that provision for bad and doubtful debts should not be deducted since this may give an impression that some amount of receivables has been collected. But when the information about opening and closing balances of trade debtors and credit sales is not available, then the debtors turnover ratio can be calculated by dividing the total sales by the balance of debtors (inclusive of bills receivables) given. and formula can be written as follows.

Debtors Turnover Ratio = Total Sales / Debtors

Example:

Credit sales $25,000; Return inwards $1,000; Debtors $3,000; Bills Receivables $1,000.

Calculate debtors turnover ratio

Calculation:

Debtors Turnover Ratio = Net Credit Sales / Average Trade Debtors

= 24,000* / 4,000**

= 6 Times

*25000 less 1000 return inwards, **3000 plus 1000 B/R

Significance of the Ratio:

Accounts receivable turnover ratio or debtors turnover ratio indicates the number of times the debtors are turned over a year. The higher the value of debtors turnover the more efficient is the management of debtors or more liquid the debtors are. Similarly, low debtors turnover ratio implies inefficient management of debtors or less liquid debtors. It is the reliable measure of the time of cash flow from credit sales. There is no rule of thumb which may be used as a norm to interpret the ratio as it may be different from firm to firm.

You may also be interested in other articles from “financial statement analysis” chapter:

1. Horizontal and Vertical Analysis
2. Ratios Analysis
3. Horizontal Analysis or Trend Analysis
4. Trend Percentage
5. Vertical Analysis
6. Accounting Ratios Definition, Advantages, Classification and Limitations:
7. Gross profit ratio
8. Net profit ratio
9. Operating ratio
10. Expense ratio
11. Return on shareholders investment or net worth
12. Return on equity capital
13. Return on capital employed (ROCE) Ratio
14. Dividend yield ratio
15. Dividend payout ratio
16. Earnings Per Share (EPS) Ratio
17. Price earning ratio
18. Current ratio
19. Liquid/Acid test/Quick ratio
20. Inventory/Stock turnover ratio
21. Debtors/Receivables turnover ratio
22. Average collection period
23. Creditors/Payable turnover ratio
24. Working capital turnover ratio
25. Fixed assets turnover ratio
26. Over and under trading
27. Debt-to-equity ratio
28. Proprietary or Equity ratio
29. Ratio of fixed assets to shareholders funds
30. Ratio of current assets to shareholders funds
31. Interest coverage ratio
32. Capital gearing ratio
33. Over and under capitalization
34. Financial-Accounting- Ratios Formulas
35. Limitations of Financial Statement Analysis

Other Related Accounting Articles:

• Creditors / Accounts Payable Turnover Ratio
• Financial Accounting Ratios & Formulas
• Fixed Assets Turnover Ratio
• Current Assets to Proprietor’s Fund Ratio
• Working Capital Turnover Ratio
• Over trading and Under Trading
• Fixed Assets to Proprietor’s Fund Ratio
• Return on Shareholders Investment or Net Worth Ratio
• Proprietary Ratio or Equity Ratio
• Expense Ratio