Accountancy · Ch 9 — Accounting Ratios
Trade Receivables Turnover Ratio
Trade Receivables Turnover Ratio
The Trade Receivables Turnover Ratio measures how efficiently a business collects the money owed by its credit customers. It tells you the number of times, on average, that trade receivables (debtors and bills receivable) are converted into cash during an accounting period.
What the Ratio Expresses
This ratio directly links credit revenue from operations (the sales made on credit) to the average trade receivables outstanding during the period. A higher ratio indicates faster collection, which is good for liquidity. A lower ratio suggests slow collection, which may tie up funds and increase the risk of bad debts.
The Formula
Trade Receivables Turnover Ratio = Net Credit Revenue from Operations / Average Trade Receivables
Where:
Average Trade Receivables = (Opening Trade Receivables + Closing Trade Receivables) / 2
Trade Receivables include both:
- Debtors (Accounts Receivable)
- Bills Receivable (Notes Receivable)
Debtors must be taken before deducting any provision for doubtful debts. The ratio uses the gross amount of receivables, not the net realisable value.
Calculating Net Credit Revenue from Operations
If the problem gives you Total Revenue from Operations and Cash Revenue from Operations, you must first find the credit portion:
Net Credit Revenue from Operations = Total Revenue from Operations – Cash Revenue from Operations
Significance of the Ratio
- Liquidity Assessment: The speed of collection directly affects the firm's short-term liquidity. Faster collection means cash is available sooner for paying liabilities.
- Collection Efficiency: A higher turnover ratio means the firm is efficient in collecting its dues.
- Average Collection Period: This ratio is also used to calculate the average number of days (or months) it takes to collect receivables. …