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. |
