Running a successful company requires SaaS founders and executives to keep many plates spinning — from operations and production to sales and marketing to product development. The list goes on and on.
But one of the most important (and often overlooked) aspects is managing the flow of cash and customer payments. After all, selling products or services is great, but you need customers to actually pay their bills to keep the lights on! While cash sales are ideal, rarely do B2B or ongoing services transactions occur without issuing a bill or invoice.
One useful metric to track how well your company is managing accounts receivable is the accounts receivable turnover ratio. In this blog, we’ll explore what accounts receivable turnover is, why it’s an important number to know, how to manage your accounts receivable, and how to calculate it using a simple formula.
What is accounts receivable turnover?
The accounts receivable turnover ratio measures the number of times a company can turn its accounts receivable into cash over typically one year. It calculates how efficiently a business is collecting payment for goods and services delivered on credit.
A higher turnover ratio indicates the company is quickly converting amounts owed by customers into cash flow available to pay vendors, employees, and other operating expenses payable by the business. Simply put, the accounts receivable turnover ratio measures how well and how fast you get paid by your customers.
What is a good accounts receivable turnover ratio?
A high accounts receivable turnover ratio is desirable as it indicates frequent and efficient collection of receivables. However, an “optimal” turnover ratio really depends on your company’s industry and current financial ratio. Setting your goals too high could place undue pressure on your customers to pay their invoices in advance and result in late or missed payments.
So, when you’re evaluating your business’s target ratio, keep your current ratio in mind — you want to ensure you have sufficient cash flow to cover any liabilities or monthly expenses in the case of missed or late payments.
Average accounts receivable turnover by industry
No two industries are the same. For example, different industries have varying expectations and norms for how quickly they convert receivables into cash. And understanding how your accounts receivable turnover ratio stacks up against industry standards is crucial for assessing your business’s financial health. Here are some average accounts receivable turnover ratios across industries:
1. Retail
Average Turnover Ratio: 9 times per year
Retail businesses often have higher turnover ratios due to frequent cash sales and shorter credit terms. For example, a study by the Credit Research Foundation found that the retail sector’s receivable turnover ratio can range from 8 to 12 times annually, depending on the specific market and economic conditions.
2. Construction
Average Turnover Ratio: 8 times per year
The construction industry typically deals with larger projects and longer payment terms, which can lead to a slightly lower ratio. According to Deloitte’s 2022 Construction Industry Report, the average turnover ratio in construction companies fluctuates between 7 and 9 times, reflecting the project’s size and client payment behaviors.
3. Manufacturing
Average Turnover Ratio: 7 times per year
Manufacturing companies often extend credit to maintain good customer relationships, which can slow down collections. A PwC survey highlighted that the manufacturing industry’s turnover ratio averages around 6 to 8 times, influenced by factors like supply chain efficiency and customer credit policies.
4. Healthcare
Average Turnover Ratio: 6 times per year
The healthcare sector faces unique challenges with insurance claims and patient billing, often resulting in a low ratio. The Healthcare Financial Management Association reports an average turnover ratio of 5 to 7 times annually, as healthcare providers navigate complex billing cycles and reimbursement processes.
These industry averages provide a helpful benchmark but remember, they are not rigid targets. Each business has unique circumstances that can affect its receivable turnover. Factors such as customer base quality, credit policies, and economic conditions play significant roles in shaping these ratios.
By comparing your accounts receivable turnover to these industry benchmarks, you can gauge where your business stands and identify areas for improvement. For instance, if your retail business has a lower ratio significantly below 9 times, it might be worth investigating your credit policies or collection processes to identify potential inefficiencies. Similarly, a construction company with a high AR turnover ratio well above the industry average might be doing an excellent job managing its receivables, signaling strong credit control and efficient collection practices.
Accounts receivable turnover ratio formula
Now that we’ve explained the theory behind accounts receivable turnover, let’s attach some numbers to it. The formula to calculate accounts receivable turnover is as follows:
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
Net Credit Sales: This is the total revenue from products and services sold on credit during a period of time, minus any returns, allowances for damaged goods, or other sales credits issued. To calculate it, take your total net sales for the period and subtract any cash sales to arrive at net credit sales.
Average Accounts Receivable: This is the average amount of receivables owed to the company over a period of time. You can calculate this metric by adding the beginning and ending accounts receivable balances for the specific period, then dividing by two.
How to calculate the accounts receivable turnover in days
The accounts receivable turnover in days shows the average number of days it takes a company to collect payment from its customers. It provides an estimate of the company’s collection period or how long funds are tied up in receivables. The formula is:
Accounts Receivable Turnover in Days = 365 days / Accounts Receivable Turnover Ratio
A lower number of days is preferable, as this indicates the business is collecting from customers quickly.
Accounts receivable turnover ratio examples
Now that you understand the turnover ratio calculation, let’s go through some more hands-on examples to see how the accounts receivable turnover ratio can provide insight into a company’s financial health and collection efficiency over a specific accounting period.
Example 1: B2B SaaS company with $5M ARR
Acme SaaS Company is a B2B accounting software firm that sells $5 million in services annually to a customer base on 30-day credit terms.
- Total net sales: $5,000,000
- Cash sales: $2,000,000
- Sales allowances: $50,000
- Beginning AR: $500,000
- Ending AR: $450,000
Acme SaaS Company’s accounts receivable turnover is 6.32 times. This means they are collecting payments from customers around every 58 days on average.
While this turnover rate is decent, it means that their customers are taking longer than the 30-day term to pay invoices. The higher ending receivables and slower turnover could indicate inefficient collection processes or trouble with certain customers paying late.
This ties up Acme SaaS Company’s working capital and cash flow. Not good.
To solve this issue, Acme SaaS Company would want to look at automating reminders for past-due invoices and consider moving their customers to COD terms if late payment is a frequent issue.
Example 2: Manufacturing company with $2.5M in annual revenue
Manufacturing Corp is a manufacturing company with these revenue and AR numbers:
- Net credit sales: $2,500,000
- Beginning AR: $300,000
- Ending AR: $350,000
Manufacturing Corp’s accounts receivable turnover is 7.69 and their turnover days is 48 days. This indicates they are collecting from customers more rapidly than Acme SaaS Company in the previous example.
The faster turnover ratio demonstrates efficient receivables management — customers are paying well within Manufacturing Corp’s 60 day terms. Their working capital is also not tied up unnecessarily in receivables, allowing them better cash flow for operations and growth.
While Manufacturing Corp’s collection processes are effective, they could still consider offering discounts for early payment to bring turnover days even lower.
What is the significance of the accounts receivable turnover ratio?
Why does the AR turnover ratio matter exactly? First of all, it’s an important metric for assessing the financial health and efficiency of a company’s credit and collections processes. A higher ratio indicates the business is efficiently converting receivables into cash flow — this improves working capital availability to fund a company’s operations and invest in growth.
A good target is a high accounts receivable turnover ratio between 5-10 times yearly. This demonstrates the company has high-quality customers and conservative credit policies. The business collects quickly from customers within payment terms. Meanwhile, a low AR turnover ratio below 3 times yearly could signal problems. More specifically, it means that the company’s cash is tied up in receivables due to inefficient collections or customers defaulting on payments. The business may need to tighten credit policies, follow up on late invoices quicker, or offer discounts for early payment.
What is the difference between accounts receivable and accounts receivable turnover?
While these two terms sound similar, there’s actually a pretty big difference. Accounts receivable refers to the total dollar balance owed to a company by its customers who purchased goods or services on credit. It represents an asset on the balance sheet reflecting money that customers have committed to pay the company in the future.
On the other hand, accounts receivable turnover is an efficiency ratio that measures how many times a company can collect, or “turn over,” its average accounts receivable balance during a period. It assesses how many times receivables are converted into cash over time. While accounts receivable is a static dollar amount, accounts receivable turnover evaluates the relationship between a company’s receivable balance, its collection policies, working capital management, and sales.
Why you should be forecasting and modeling your accounts receivable
If you want to start improving your AR turnover ratio, the logical next step is to set up a forecasting model.
In addition to monitoring current turnover metrics, developing robust forecasts for future accounts receivable activity is crucial for effective financial planning and cash flow management. Rather than relying solely on point-in-time turnover ratios, you should leverage historical receivables data to identify relevant trends, cycles, and patterns that can inform projections. And with tools like Maxio’s accounts receivable aging report, you can easily drill down into these metrics and uncover any pain points that are hurting your AR turnover ratio.
Once you get your hands on these metrics, analyzing any seasonal fluctuations that correlate with monthly, quarterly, or annual cycles can provide insight into anticipated timing of customer payments. Then, examining the historical differences in payment behaviors across customer segments, industries, or geographies will also allow you to model distinct payment patterns that are tailored to your unique customer and revenue mix.
Likewise, factoring in forecasts for sales growth will give your teams guidance into any expected expansion of receivables balances and turnover capacity. And evaluating days sales outstanding (DSO) metrics and accounts receivable aging over time offers perspective on average collection periods to model going forward.
A few ways to improve your accounts receivable turnover ratio
Improving accounts receivable turnover requires an ongoing, multi-faceted approach.
You should start by reviewing your credit policies and carefully evaluating criteria for new customers, credit limits, and payment terms. Tightening policies even incrementally for higher-risk segments can pay dividends in reducing late or missed payments from your customer base. Automating your collections through dedicated SaaS AR software is another impactful strategy — features like Maxio’s automation of invoice reminders, tracking of past-due accounts, and streamlined workflows can significantly boost your finance and accounting team’s ability to collect on late or missed payments.
Then, once you have access to these AR tools, your employees who are responsible for AR should incorporate dunning best practices and follow up diligently on any invoices approaching 30 days past-due. A quick check-in call, email, or letter to high-value customers can get payments back on track before they become seriously delinquent. And offering discounts for early payment, such as a 2% discount for payment within 10 days, provides customers with an incentive to pay ahead of schedule.
Get payments in the door with Maxio
Managing accounts receivable efficiently is vital for healthy cash flow. Otherwise, outstanding debt and bad debt will tie up your working capital and strain your operations. And to make matters worse, this isn’t a problem you can tackle using Excel alone. Manual tracking in spreadsheets is both time-consuming and prone to errors. Even one small data entry mistake could cause your model to crumble and make your investors question their confidence in your company.
Fortunately, there are tools like Maxio specifically designed for B2B SaaS companies to streamline their accounts receivable at scale. A sneak peek at some of Maxio’s key features include automated invoicing, real-time tracking of outstanding debt, payment reminders, integration with existing accounting systems, and customizable reporting (just to name a few).
Want to start improving the AR turnover in your company? Check out our AR page for more information.
