Cash flow is the lifeblood of every business. Whether you sell products or services, you need to collect payment from your customers in order to pay your own bills and employees. However, when you extend credit to your customers (instead of receiving a cash payment immediately), you may not be collecting payments as efficiently as you need to. That’s where the Accounts Receivable Turnover Ratio comes in handy for helping you assess where you are with payment collection and how you could improve. Keep reading for everything small business owners need to know about Accounts Receivable Turnover Ratio.
What is the Accounts Receivable Turnover Ratio (ARTR)?
Also known as the receivables turnover, this number shows how often a company’s accounts receivable balance is collected in a given period. Tracking your ARTR is important because it helps you understand how efficient your collection process is. If credit card payments aren’t coming in as quickly as expected, your business may experience cash flow problems.
Generally, a higher ratio indicates that your business is successfully and efficiently converting credit sales to cash. However, businesses must balance a high ARTR with offering reasonable invoice terms. Depending on the type of business you have, or the companies you work with, you may have no choice than to accept a longer-than-30-day payment cycle. Once you have an idea of your ARTR, you can use this data as a benchmark to compare your business’s performance to others within your industry.
How do I calculate my Accounts Receivable Turnover Ratio?
The formula for calculating your receivables turnover ratio is as follows:
Net Credit Sales Average Accounts Receivable = Accounts Receivable Turnover
Let’s take a closer look at these terms.
- Net Credit Sales: The amount of revenue earned from credit payments during a specific time period, such as one quarter or one year. Do not include any payments made immediately in cash. This number is usually available on your company’s income statement or balance sheet.
- Average Accounts Receivable: The average between your starting and ending accounts receivable balances (add your starting and ending balances and then divide by two). Again, only use a specific time period to calculate this number.
For example, let’s say your total credit sales (minus returns or allowances) for the year are $100,000.
You started the year with an accounts receivable balance of $10,000 and ended with a $30,000 balance. $40,000 divided by two = an average accounts receivable of $20,000.
Finally, $100,000 divided by $20,000 = 5. This means that your company collects its average receivables amount five times a year.
As mentioned in the previous section, the higher your ARTR, the better. The faster you receive credit payments, the smoother your cash flow will be. Getting paid yourself allows you to pay your business’s bills and meet obligations like payroll. A high ARTR is also a sign that your invoice terms and collection methods are effective, as well as that your customers are trustworthy in paying on time.
What steps can I take to improve my ratio?
If you want to improve your company’s Accounts Receivable Turnover Ratio, look for ways to more effectively manage your billing and collections process. For example:
1. Improve invoicing strategies.
The sooner and more effectively you invoice your customers, the faster you can close the gap in your accounts receivable process. Engage in strategies to improve your invoicing process, such as sending out bills on time and as often as necessary, having a payment system for your sales, etc. Taking steps to automate this process can streamline it without putting additional strain on your team.
2. Improve communication with customers.
If your customers are slow to pay, take steps to improve communication with them. People are inundated with messages and to-do’s, so it’s easy to forget about your invoice even if they are not trying to You may want to use emails, texts, and phone calls to follow up with customers regularly. Just keep the tone of these communications friendly to ensure that you maintain a positive rapport with customers.
3. Make the payment process easy.
Giving customers more ways to pay their bills gives you more avenues to collect payments from customers. You’ll get paid more quickly and your customers will appreciate the convenience of choosing from multiple payment methods. For example, you might want to accept online payments through Apple Pay or PayPal as well as cash and checks.
4. Clarify your payment terms.
Be sure that your invoice payment terms are easily available to customers. Your terms should make it clear how you expect to be paid, if a certain amount is due upfront, how long the customer has to pay, any late charges, and so on. This places more accountability on customers and provides some degree of pressure to ensure that they submit payments on time.
How does Cogent Bank help small businesses?
Is your business experiencing cash flow issues? We can help. Cogent Bank offers customized business banking solutions to help you improve your cash flow.
Check out our Electronic Data Interchange (EDI), which offers automated collection processes to help you accelerate payment and collection, operate more efficiently, enjoy greater flexibility, and save time and money.
Increase your cash on hand with Insured Cash Sweep® (ICS) and IntraFi, which allow you to earn interest on funds in demand deposit accounts and/or money market accounts. You’ll have the peace of mind of knowing your ICS funds are eligible for multi-million-dollar FDIC insurance.
We also offer a complete list of Treasury Management services including ACH Origination, ACH Positive Pay, Business Online Payroll, Check Positive Pay, and more. To learn more, connect with a Cogent associate. We will discuss your business needs and challenges with you, and help you find the solutions to move your business forward.