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# Debtors Turnover Ratio or Receivable Turnover Ratio:

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## Definition and Explanation:

Ratio of net credit sales to average trade debtors is called debtors turnover ratio. It is also known as receivables turnover ratio. This ratio is expressed in times.

Accounts receivables is the term which includes trade debtors and bills receivables. It is a component of current assets and as such has direct influence on working capital position (liquidity) of the business. Perhaps, no business can afford to make cash sales only thus extending credit to the customers is a necessary evil. But care must be taken to collect book debts quickly and within the period of credit allowed. Otherwise chances of debts becoming bad and unrealizable will increase. How effective or efficient is the credit collection? To provide answer debtors turnover ratio or receivable turnover ratio is calculated.

## Formula:

Following formula is used to calculate debtors turnover ratio:

Receivables turnover ratio = Annual net credit sales / Average accounts receivables

Where accounts receivables = Trade debtors + Bills receivables

Figure of trade debtors for this purpose should be gross i.e. provision for bad and doubtful debts should not be deducted from the amount of debtors. Receivables collection period (also known as average collection period) is calculated and supplemented with the receivables turnover ratio to help better understanding and communication.

## Interpretation:

Normally higher the debtors turnover ratio better it is. Higher turnover signifies speedy and effective collection. Lower turnover indicates sluggish and inefficient collection leading to the doubts that receivables might contain significant doubtful debts. Receivables collection period is expressed in number of days. It should be compared with the period of credit allowed by the management to the customers as a matter of policy. Such comparison will help to decide whether receivables collection management is efficient or inefficient.

## Example:

From the following particular calculate Receivables turnover ratio and average collection period

 \$ Annual total sales 49,50,000 Cash sales (included in above) 6,25,000 Sales returns 75,000 Opening balance of receivables (net) 3,60,000 Closing balance of receivables (net) 4,00,000 Provision for bad and doubtful debts (opening) 40,000 Provision for bad and doubtful debts (closing) 50,000

Solution:

Working:

 Annual credit sales (net) \$ Total sales 49,50,000 Less: Cash sales 6,25,000 Less: Sales returns 75,000 7,00,000 42,50,000 Average receivables: Opening receivables (net) 3,60,000 Add: Provision opening 40,000 Add: Closing receivables (net) 4,00,000 Add Provision closing 50,000 8,50,000 Average (i.e. 8,50,000 / 2) \$4,25,000

Receivables turnover ratio = Annual credit sales (net) / Average accounts receivables

= 42,50,000 / 4,25,000

10 times

Receivables collection period = No. of days in the year / Receivable turnover ratio

= 365 / 10

= 36.5 approx. or 37 days.

More study material from this to

## More study material from this topic:

 Meanings, Nature and Usefulness of Ratios Analysis Interpretation of Ratios Important Factors for Understanding Ratios Analysis Significance and Usefulness Ratios Analysis Classification of Ratios Analysis of Short Term Financial Position or Test of Liquidity Current Ratio Quick/Acid Test/Liquid Ratio Absolute Liquid Ratio Inventory/Stock Turnover Ratio Debtors / Receivable Turnover Ratio Creditors / Payables Turnover Ratio Working Capital Turnover Ratio Profitability Ratios Gross Profit Ratio (GP Ratio) Operating Profit Ratio Net profit ratio (NP ratio) Earnings Per Share Ratio Operating ratio Expense ratio Solvency ratios - Test of Long Term Solvency Debt-equity Ratio Debt Service Ratio or Interest Coverage Ratio Fixed Assets Ratio Debts to Total Funds or Solvency Ratio Reserves to Capital Ratio Capital Gearing Ratio Proprietary Ratio Accounting Ratios Formulas Limitations of Ratios Analysis

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