Finance / Ratio Analysis · May 7, 2022

How To Increase The Accounts Receivable Turnover Of A Company

What is Accounts Receivable Turnover

Accounts receivable turnover is a ratio that is used to determine if a company is actually receiving the cash or cash equivalent in their bank account after selling their products / services.

Accountants and analysts use accounts receivable turnover to determine how well a company collects on the credit it extends to its customers.

When a company sells its products / service, it has two choice to offer to its customers: either take upfront cash for the product or provide a credit for customer.

In case where a company provides a credit, the sale has already been made, but the cash has not been received from the client.

For an ideal scenario, the account receivable turnover should always be greater than 20. This means, for every Rs. 100/- earned by the company, the maximum allowable credit should be Rs. 5/-

If the accounts receivable turnover is less than 2.5, it indicates that the company is unable in receiving the amount from their customers even after the sale of product has been made.

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Formula to calculate the account receivable turnover

Account Receivable Turnover = Total sales made by the company / Net credit provided

Where,

The total sales by the company is the total quantum of sale a company has made in a particular year. This includes the amount received in cash as well as the credit provided to the customers.

Net credit provided is the total amount of credit the company has provided to the customers to make the sale of their product.

This value is a ratio, where a high number indicates that a company collects most of the money upfront and gives less credit to its customers. On the other hand, if this value is less than 2, it indicates that the company is providing 50% of its sales on credit.

Here are 5 ways to increase the Accounts Receivable Turnover of a company

  1. Selling products on EMI
  2. Using technology to receive payments
  3. Automating the sales process
  4. Transfer the risk to your vendors
  5. Providing festive discounts

Let us understand these processes in detail.

5 ways to increase the Accounts Receivable Turnover of a company

Selling products on EMI

Providing an EMI (Equated Monthly Installment) option to the customers reduces your risk as a creditor. It also provides the consumer with the product without paying the amount in full.

Selling products on EMI is a great option to drastically reduce the account receivable turnover of a company.

The companies in this case received the money at full from the banks on behalf of the customer. Hence, these customers are now liable to repay this money banks after a said duration.

Best ways to sell products on EMI

  • Accepting payments through credit cards.
  • Partnering with the “buy now pay later” apps.
  • Partnering with EMI lending banks and companies.

Using technology to receive payments

In today’s times, technology has been a great driver for the companies to increase their sales exponentially. It is common to see that many merchants use QR code to scan and make payments. The use of technology and digital payments reduces the friction between the customers to buy a product.

This is of significant advantage to the merchants as the money is paid upfront by the customer. Thus, increasing the accounts turnover for the company.

Automating the sales process

In the times of technology, humans have been replaced by robots and the human interaction have been replaced by the artificial intelligence. Automating the sales process allows the company to thoroughly keep track of all the sales and receivable cash.

Also, by automating the sales, there is no room left for the company to provide direct credit to its customers. Automation in sales can also help in scaling the business of the company, thereby increasing the net revenue.

Best ways to automate sales

  • Selling products on marketplace like Amazon and Flipkart
  • Creating your own website / apps to sell products.

Transferring the risk to the vendors

When the risk is transferred to the vendors, the company reduces its risk in case its customers becomes a defaulter to repay the loan. The company does not lose the money in first hand and has a time limit to settle all its dues with their vendors.

For example, if a company is in selling of clothing, it will take credit from the vendor to procure the raw material to make these clothing apparels. Thus, if the company still provides the clothes on credit, it will not directly affect the accounts receivable ratio.

Providing festive discounts

Providing discounts in the times of festive sales can push up the revenues of the company to a significant extent. Festive time is a period where the customers go easy on their wallet and tend to spend on products.

Providing a discount not only increases your revenues but also gives an opportunity to your customers to buy the products at a much cheaper price.

Conclusion

True profits are only realized when the companies receives the payment in full in their banks and the account books. One needs to understand to differentiate between the book profits and true profits. These steps can help a company to increase their account receivable turnover.

It is to be noted that some companies, particularly in the B2B business have no option but to provide their material on credit. Providing a credit is not totally bad for the business. But the same needs to be properly monitored by using accounts receivable turnover formula.

Also Read: How To Calculate Price To Earning (PE) Ratio Of A Stock

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