Two financial measures that are especially useful in evaluating efficiency in collecting receivables are (1) the accounts receivable turnover and (2) the number of days’ sales in receivables.
The accounts receivable turnover measures how frequently during the year the accounts receivable are being converted to cash. For example, with credit terms of n/30, the accounts receivable should turn over about 12 times per year.
The accounts receivable turnover is computed as follows:5
The average accounts receivable can be determined by using monthly data or by simply adding the beginning and ending accounts receivable balances and dividing by two. For example, using the following financial data (in millions) for FedEx, the Year 2 and Year 1 accounts receivable turnover is computed as 8.0 in Year 2 and 8.1 in Year 1, as shown below.
The number of days’ sales in receivables is an estimate of the length of time the accounts receivable have been outstanding. With credit terms of n/30, the number of days’ sales in receivables should be about 30 days. It is computed as follows:
Average daily sales are determined by dividing net sales by 365 days. For example, using the preceding data for FedEx, the number of days’ sales in receivables is 45.9 and 45.1 for Year 2 and Year 1, as shown below.
The number of days’ sales in receivables confirms that FedEx’s efficiency in collecting accounts receivable decreased slightly from Year 1 to Year 2. Generally, the efficiency in collecting accounts receivable has improved when the accounts receivable turnover increases or the number of days’ sales in receivables decreases.
Source: Warren Carl S., Reeve James M., Duchac Jonathan (2013), Corporate Financial Accounting, South-Western College Pub; 12th edition.
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