Debtors Turnover Ratio or accounts receivables turnover ratio indicates the total number of times debtors are changed into cash during one financial year. Also referred to as the efficiency ratio, it measures an establishment's ability to collect overall revenue. Simply put, it also helps interpret the efficacy of using a firm's assets optimally.
What is the Debtors Turnover Ratio?
Debtors Turnover Ratio and definition are analyzed above. So, now you understand what is debtors turnover ratio. In any business, sales occur via cash and credit. If sales occur in credit, the other individual owing the money is called the debtor.
Given the sale of the goods on credit, the payments would be delayed. So, the overall cash receivable is regarded as the accounts receivable. So, the debtors turnover ratio happens to be the account receivables turnover ratio. It is an effective financial tool that helps calculate the exact number of times average debtors convert into cash during a fiscal year.
Truth be told, it is the total number of times the average debtor has changed into cash during the fiscal year. A surprising fact is that it is also popular as the efficiency ratio. The prime objective of this ratio is to analyse a firm's ability to save revenues. Besides, it can also interpret the effectiveness of using a company's assets.
Understanding the Debtors Turnover Ratio
What if there's a high turnover ratio? Simply put, it means the collection tactics are sound and effective. It also means that the customers are paying their debts on time. However, with a low debtor turnover ratio, a company may experience inefficiency in the collection process. Also, the firm may experience inaccurate credit policies too.
Investors must be mindful of using total sales rather than net sales. The main objective is to compute ratios that inflate the overall results.
So, firms can use accounts receivable loans for customers because they come without any interest and are short terms. In that case, a company can extend the time for paying for 30 to 60 days. So, customers get the benefit of paying the money within this time frame.
Note that a debtors turnover ratio can assess the company's efficacy of collecting receivables or credit extending to the consumers. That's not the end of the picture. The ratio can also evaluate the times the receivables have been changed to cash for a specific company. The ratio is easily calculated monthly, quarterly, or even annually.
Formula and Calculation of the Debtors Turnover Ratio
You need to be careful while calculating the debtors turnover ratio. If you wish to compute the amount, it is imperative to follow the given points:
First Things First: The Credit Sales Should be Determined
As long as you have assessed the credit sales, half the job is done. Truth be told, you need to evaluate credit sales. Evaluate the amount by subtracting the allowances or returns from the total credit sales. After you find out about the credit sales number, you can proceed with the next step
Next is Evaluating the Amount of Accounts Receivable
After you get the value for credit sales, you now need to evaluate the accounts receivables. It is the amount owed to any business by customers. Find the amount by including the accounts receivable number at the start of the year. Now, you can add the amount to the accounts receivable value at the end of the year. After this, you need to divide the number by two. And there you have the answer.
Lastly: Applying the Formula Evaluates the Ratio's Amount
Now that you are ready with the values, you can include them in the formula to find out the accounts receivable. Divide the credit sales by the average amount to get the ratio.
Importance of Debtors Turnover Ratio
A company can reap a wide range of benefits from the debtors turnover ratio. Some of them are highlighted below:
Helps Evaluate the Excellence of the Company in Collecting Credit Sales
So, the first benefit a company gets from the debtors turnover ratio is the speediness of collecting credit sales. If a company processes the balances faster, it achieves capital more speedily.
Helps the Company Make Capital Investments
If a company gains the ability to quickly exchange the receivable balances into a cash amount, it can project the money for the future.
Lets the Company Outshine the Competition
When measuring financial ratios, the company may understand whether or not it can outshine others. Even if it falls behind, the company can assess its condition accordingly.
A Company's Sufficiency in Evaluating the Client's Credit
So, another important benefit is that the organization can easily review the creditworthiness of the customers. Also, with a slower turnover, they will understand what resulted in clients being insolvent. They learn why the client cannot pay the cash amount timely.
Gains Collateral Opportunities
A strong receivable activity will result in the company borrowing a fund.
Limitations of the Debtors Turnover Ratio
The downfalls of the debtors turnover ratio are mentioned below:
● Some organisations use sales instead of net sales to calculate the ratio. It leads to improper calculation, making it more difficult for the company to compute things.
● Another limitation is that the accounts receivable may vary throughout the year.
So, when selecting the ending and beginning values, it is imperative to calculate the average amount. Note that it reveals the firm's overall performance.
Example of Debtors Turnover Ratio
Let's consider that a company, ABC, has made net credit sales of Rs. 200,000 for a year with a sales return amount of Rs. 20,000. The accounts receivables amount is Rs. 25,000.
To find out net credit sales, follow this debtors turnover ratio formula:
Net Credit Sales = Sales ( minus ) Sales returns
So, Rs. 200,000 - INR 20,000 = INR 180,000
You already know that the average accounts receivable is Rs. 25000.
Considering the debtors turnover ratio formula, the turnover ratio is:
180,000/25,000 = 7.2
Hence, the debtors turnover ratio amount is 7.2.
So, these are the things you need to learn about debtors turnover ratio meaning and its definition, limitations, benefits, etc.
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Frequently Asked Questions
Debtors Turnover Ratio is the accounts receivables turnover ratio that suggests the total number of times debtors are changed into cash during one fiscal year. It is also referred to as the efficiency ratio.
A higher number is better since it lets customers pay timely.
A loose or nonexistent credit policy, a huge proportion of customers with financial issues, or inadequate collections may affect the debtors turnover ratio and result in low receivable turnover.
A high debtors turnover ratio is important because it indicates the company's accounts receivable collection is efficient. It has a great proportion of quality, so customers pay debts on time.