Trade Receivables Turnover Ratio: Meaning, Formula, Significance and Illustration

The Trade Receivables Turnover Ratio, also known as the Accounts Receivable Turnover Ratio, is a financial activity ratio that measures how effectively a business collects payments from its customers for credit sales. It evaluates the efficiency of a company’s credit and collection policies by showing how many times average trade receivables are converted into cash during a specific period. The ratio is calculated by dividing net credit sales by average accounts receivable. A higher Trade Receivables Turnover Ratio indicates that the company collects its dues quickly, which reflects efficient credit management and strong liquidity. On the other hand, a lower ratio suggests delays in collection and may indicate inefficiency in managing receivables, which can negatively affect cash flow. Therefore, this ratio is an important indicator of a company’s short-term financial efficiency and credit control system

Net Credit Sales and Average Accounts Receivables can be defined as:

Net Credit Sales: These are the total sales a business made on credit over a certain time period less any returns or discounts that were offered. (Net Credit Sales = Total Sales - Cash Sales)

Average Accounts Receivable: It is the term used to describe the typical sum of money that clients owe a business for products or services they purchased on credit. It is determined by multiplying the accounts receivable beginning and ending balances by two.

Formula:

Trade~Receivables~Turnover~Ratio =\frac{Net~Credit~Sales}{Average~Accounts~Receivable}

Significance:

The Trade Receivables Turnover Ratio is a crucial indicator of how well a company's credit and collection strategies are working. A greater ratio shows that a business is producing cash flow more swiftly by collecting receivables more quickly. A smaller ratio, on the other hand, shows that a business is taking longer to collect its receivables, which can have a detrimental effect on working capital and cash flow.

Illustration 1: 

Calculate Trade Receivable Turnover Ratio from the following data:

Solution: 

Trade~Receivables~Turnover~Ratio =\frac{Net~Credit~Sales}{Average~Accounts~Receivable}

Credit Revenue from Operations = Total Revenue - Cash Revenue

Credit Revenue from Operations = ₹4,00,000 - ₹80,000

Credit Revenue from Operations or Net Credit Sales = ₹3,20,000

Average Trade Receivables = \frac{Opening~Trade~Receivables+Closing~Trade~Receivables}{2}

Average Trade Receivables = \frac{40,000+1,20,000}{2}

Average Trade Receivables = ₹80,000

Trade~Receivables~Turnover~Ratio =\frac{3,20,000}{80,000}

Trade Receivables Turnover Ratio = 4 Times

Illustration 2: 

Calculate Debtor Turnover Ratio from the following information:

• Total revenue from operations: ₹10,40,000
• Cash revenue from operations is 30% of credit revenue from operations
• Closing Debtors: ₹1,60,000
• Opening debtors are \frac{3}{4} of closing debtors

Solution:

Debtor~Turnover~Ratio =\frac{Net~Credit~Sales}{Average~Accounts~Receivable}

Computation of Credit Revenue from Operations:

Let Credit Revenue from Operations = ₹100

Therefore, Cash Revenue from Operations = ₹30

and Total Revenue from Operation = ₹130

Therefore, Net Credit Revenue from Operation = \frac{10,40,000}{130}\times100=₹8,00,000

Computation of Average Debtors:

Closing Debtors = ₹1,60,000

Opening Debtors = \frac{3}{4}\times1,60,000=₹1,20,000

Average Debtors = \frac{Opening~Debtors+Closing~Debtors}{2}

Average Debtors = \frac{1,60,000+1,20,000}{2}=₹1,40,000

Debtor~Turnover~Ratio =\frac{8,00,000}{1,40,000}

Debtor Turnover Ratio = 5.71 Times

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