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.

Formula of Debtors Turnover Ratio:

[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 relevant articles: Horizontal Analysis or Trend Analysis Trend Percentage Vertical Analysis Limitations of Financial Statement Analysis Accounting Ratios definition, advantages, classifications and limitations Financial Ratio Formulas Profitability ratios: Gross profit ratio Net profit ratio Operating ratio Expense ratio Return on shareholders investment or net worth Return on equity capital Return on capital employed (ROCE) ratio Dividend yield ratio Dividend payout ratio Earnings Per Share Ratio Price earning ratio Liquidity ratios: Current ratio Liquid /Acid test / Quick ratio Activity ratios: Inventory/Stock turnover ratio Debtors/Receivables turnover ratio Average collection period Creditors/Payable turnover ratio Working capital turnover ratio Fixed assets turnover ratio Over and under trading Leverage ratios or long term solvency ratios: Debt equity ratio Proprietary or Equity ratio Ratio of fixed assets to shareholders funds Ratio of current assets to shareholders funds Interest coverage or debt service ratio Capital gearing ratio Over and under capitalization

 

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