Understanding accounts receivable turnover ratio: Why it’s important for your business

For any business, this smooth cash flow is as crucial as maintaining operational stability for long-run growth. Among the financial metrics calculated, one that is essentially crucial in cash flow assessment is the Accounts Receivable Turnover (ART) Ratio. This ratio measures how well a company is managing its receivables—how efficiently it collects payments from customers. It does not matter whether you are a startup or an established organization; understanding and improving the ART ratio can enhance your business’s financial health.

We’ll examine what the Accounts Receivable Turnover ratio is, how it’s calculated, the importance of this ratio to businesses’ operations, and how it can be optimized to enhance cash flow. To that end, we shall discuss outsourcing and its part in handling receivables, which includes how Mehasa Consulting can help improve the ART ratio for businesses.

What is the Accounts Receivable Turnover Ratio?
Accounts Receivable Turnover Ratio The Accounts Receivable Turnover Ratio measures the number of times a firm collects its average accounts receivable over an operating period, typically one year. In other words, it reflects how a business successfully sells credit sales on account. A high ART ratio suggests efficient collections and healthy cash flow, while a low ratio may indicate problems in the credit or collection process.

Formula for Calculating the Accounts Receivable Turnover Ratio
The formula to compute the ART ratio is very simple and straight:
ART = Net Credit Sales / Average Accounts Receivable
Here,
Net Credit Sales: Credit sales made during a particular period; exclude returns and allowances.
Average Accounts Receivable: Average of the amount of money due by customers over a particular period. It is computed as the sum of the accounts receivable at the start and end of a period divided by two.
Example of ART Calculation
Your company has Net Credit Sales of $500,000 for the year. At the beginning of the year, the accounts receivable was $50,000, and at the end of the year, it was $70,000.

First, determine the average accounts receivable:

Average Accounts Receivable
=
50
,
000
+
70
,
000
2
=
60
,
000
Average Accounts Receivable=
2
50,000+70,000
​​
=60,000
Next, use the formula:

ART
=
500
,
000
60
,
000
=
8.33
ART=
60,000
500,000
​​
=8.33
This indicates that the company collects its average accounts receivable 8.33 times in a year.

Why Is the Accounts Receivable Turnover Ratio Important for Your Business?
One of the major indicators about your company’s financial health is the ART ratio. It gives an idea of how well the credit and collections process within your business is managed; in short, cash flow.

1. Cash Flow Management
This would effectively help to collect receivables and yield on-time cash inflow for paying the operational costs of your business, such as payment to suppliers, employees, etc. A high ART ratio indicates that your business is quick at collecting cash from its receivables, thereby maintaining steady cash inflow. A low ART ratio might indicate a cash flow problem in your business, possibly due to slow-paying customers or ineffective collection processes.

2. Credit Policy Assessment
It also reflects your success in credit policies. A high ratio mostly means that credit terms are successful, and customers pay on time. A low ratio may mean that your credit terms are too lenient or that your collection process needs improvement. Regular evaluation of the ART ratio can help you determine whether adjustments to your credit policies are needed to ensure smoother cash flow.

3. Evaluation of Liquidity Position
Your ART ratio is an indication of how the finances are in your company. Consistent high ratio implies that your business is collecting receivables effectively, which reflects good management of finance. Low ratio suggests that there are problems in accounts receivable management, poor customer creditworthiness, or poor credit check. With proper monitoring, these issues can be seen much ahead in time, so that correct measures can be taken on time to ensure financial stability for the business.

Improve Your Accounts Receivable Turnover Ratio
You need to have a better accounts receivable management strategy to improve your ART ratio. Following are a few strategies that can prove helpful:

1. Adopt Effective Credit Management
One of the first steps toward improvement in your ART ratio is ensuring you have a good credit management policy. Tighten the terms of credit, decrease the payment period, and check for proper credit before giving any customer credit. You will definitely avoid slow payments and bad debts because of the assessment of the creditworthiness of the customer before allowing credit to him.

2. Proper Invoicing and Follow-Up
The sooner you send out a bill after a transaction happens, the sooner your clients will pay. Additionally, make sure that your team starts following up on overdue payments before it gets too late. Start a routine system of reminders through mail, phone calls, or letters so that there is no payment that sneaks past.

3. Technology
State-of-the-art accounting software could thus considerably lighten up the receivables management process. Tools for automatic invoicing, reminding payers of payments outstanding, and real-time tracking would minimize human error and enable effective account management to result in an excellent ART ratio.

Role of outsourced accounting services in managing ART
Outsourcing accounts receivable management is the key to further optimizing accounts receivable processes for businesses. Professional firms that have experience in managing receivables can take charge of the entire process from invoicing to collections. This would be beneficial for companies that lack resources to manage receivables in-house or are keen to focus on other core business activities.

How Mehasa Consulting Can Help
Mehasa Consulting is the outsourcing accounts receivable management specialist for businesses. The firm helps companies enhance their ART ratio and improve cash flow generally. Here’s how outsourcing to Mehasa Consulting will benefit your business:

Better Cash Flow: Mehasa ensures timely invoicing and follow-ups, which means a reduction in the time it takes to collect payments and therefore boosts cash flow.
Lower Operating Expenses: Third party accounts receivable service providers ensure no in-house accounts receivable department and reduce overhead costs allowing one to focus on the growth of a business.
Professionalism and Minimization of Error: Experienced accounts receivable management has served Mehasa Consulting over the years through the help of advanced technologies and best practices implemented by the industry.
Customized Solutions: Mehasa tailors its services to suit your business’s specific needs, offering everything from credit vetting to automated invoicing and collections.

Case Study: Improving ART Through Outsourcing
A mid-sized manufacturer faced low ART ratio and low cash flows with high outstanding receivables. Since this outsourcing of accounts receivable management to Mehasa Consulting, the company noticed significant improvements.
Before outsourcing, the company had a low ART ratio of 4 that indicated inefficiencies in collection and slow payments from customers.
Outsourcing Benefits: Mehasa studied the current process of the company, established credit policies, and automated billing and collections.
Outcome: Six months’ time resulted in the ART ratio for the company to improve to 8, which is a much better sign of receivable management. This improvement showed better cash flow and thus a healthier financial position.
Common Mistakes in Account Receivable Turnover Ratio Management
While improving your ART ratio, avoid these pitfalls that can hinder your own progress.

Overextension of Credit: Extension of credit to customers without establishing their ability to pay is likely to result in bad debts and slow payments. Always establish credit before offering credit terms.
Poor Invoicing: Invoicing or collections that are late result in a long receivables period. Ensure your invoicing and collections are prompt and consistent.
Failure to track and analyze the ART ratio regularly will cause one to miss the chances of improvement.
Conclusion
Assess the efficiency of your business through use of the ART ratio. There has always been a relationship between an improvement in the ART ratio and company efficiency in collecting receivables, thus resulting in sustained cash flow and strong health from financial perspectives. The credit policy, invoicing procedures, technology, and outsourcing would be some ways to obtain better results.

The right strategies will turn your business upside down in receivables management, bringing in faster collections, better cash flow, and a stronger bottom line.

Frequently Asked Questions
Q1: What is considered a good Accounts Receivable Turnover?
This is again industry sensitive but in general the higher the ratio is better. The ideal rate for an ART ratio varies from 7 to 10 and shows that the payments are collected efficiently by the company.

Q2: How frequently should one calculate the ART?
It is best calculated at least quarterly but monthly calculation will be timely and helpful for swift adjustments.

Q3: Can a high ART ratio ever be bad?
While a high ART ratio is generally positive, it can sometimes indicate overly strict credit terms, which could limit sales growth. Balancing credit policies is key to optimizing both your ART ratio and business expansion.

Implementing the most appropriate techniques and professional outsourcing services can also do wonders for accounts receivables of businesses, as can be gained using the outsourcing service provision that Mehasa Consulting company provides.