I. Introduction
The Trade Receivables Turnover Ratio is a financial metric that helps to evaluate how well a company can manage its receivable accounts or outstanding balances from clients. It measures how many times a company collects its receivable accounts on average within a specific period—a year. So, whether you are a business professional or an investor, learning about the Trade Receivables Turnover Ratio is essential to managing your finances well.
A. A brief overview of financial ratios
Financial ratios are a tool that investors use to gain information and analyze the financial state and history of a company or a specific sector. They are equally important for business professionals to learn about their financial growth and maintain a healthy balance sheet.
B. The importance of managing trade receivables
Trade receivables are also known as account receivables. Maintaining a healthy rate of accounts receivable and managing them efficiently is essential for any company’s financial health. On the other hand, a good rate of trade receivables on a company’s balance sheet indicates a good opportunity to invest.
C. Focus on Trade Receivables Turnover Ratio (TRTR)
The Trade Receivables Turnover Ratio is also known as the account receivables turnover ratio or TRTR. It measures the frequency of a company in turning its accounts receivables into cash within a specific time period, which is usually less than a year. The ratio of accounts or trade receivables can vary from one industry to another. However, a ratio of 7.8 or more in account receivables is considered good or healthy for the company’s financial state.
II. Understanding Trade Receivables Turnover Ratio
The Trade Receivables Turnover Ratio plays a pivotal role in a company’s financial health. It is a financial metric that helps to calculate the turnover of a company’s account or trade receivables within a specific time period.
A. Definition and purpose
By definition, the Trade Receivables Turnover Ratio is also known as the debtors’ receivables turnover ratio or account receivables turnover ratio. It is a financial metric essential for calculating financial ratios. The primary purpose of the trade or account receivables turnover ratio is to evaluate the efficiency or ability to smoothly manage the credit the company is owed.
B. Significance in evaluating financial health
When it comes to evaluating the financial health of a company, TRTR or Trade Receivables Turnover Ratio plays a crucial role. This metric helps to calculate the frequency or the number of accounts receivable the company turns into cash within a specific time frame—one year or less. So, when a company tries to consistently evaluate and maintain a healthy financial ratio on the company’s balance sheet.
C. Link to cash flow and liquidity
TRTR has a direct link with the cash flow and liquidity of a company’s financial structure. A good account receivables turnover ratio or Trade Receivables Turnover Ratio indicates significant and higher cash flow in the company, while a low or poor TRTR suggests lower cash flow. On the other hand, the trade receivables turnover ratio also helps a similar relationship with the liquidity ratio of the company. The better the TRTR is, the higher liquidity it indicates, and the lower ratio indicates vice versa.
Read More: Unlocking the basics of Statutory Liquidity Ratio (SLR) in India: A comprehensive guide
III. Calculating the Trade Receivables Turnover Ratio
To calculate the Trade Receivable Turnover Ratio, one must calculate average account receivables and net credit sales. Below is the formula for the calculation of TRTR.
A. Formula breakdown
First, calculate the Average Accounts Receivable. Use this formula:
(Starting balance + Ending balance) / 2 = Average Accounts Receivable
After that, find out the Annual Net Credit Sales using the formula below:
(All credit sales – Total returns) – Sales allowances = Annual Net Credit Sales
Next, you could use the formula here to find out the Account Receivable Turnover Ratio:
Annual Net Credit Sales/ Average Account Receivable = Account Receivable Turnover Ratio
Finally, calculate the TRTR in days with the formula:
365/ Receivable Turnover Ratio = Trade Turnover Receivable In Days
B. Explanation of key components
Two primary components of the calculation of the Accounts Receivable Turnover Ratio are Average Accounts Receivable and Net Credit Sales.
- Average Accounts Receivable: Average Accounts Receivable is the denominator of TRTR. Its calculation process includes the balance of starting account receivables and ending account receivables.
- Net Credit Sales: Annual Net Credit Sales, or simply Net Credit Sales, is the numerator of the TRTR. It indicates the amount of revenue a company earns through credit. Using a consistent time frame is necessary while calculating NET Credit Sales.
C. Illustrative example for clarity
Below is an example of the Account Receivable Turnover Ratio calculation:
Let us assume that a company’s Average Accounts Receivable is $64,000 at the start of a year and $72,000 at the end of that year. And the Net Credit Sales is $800,000.
To calculate the Average Accounts Receivable find the Average Accounts Receivable as follows:
$64,000+$72,000/2 = $68,000
To calculate TRTR, divide the net credit sales by this number. That is:
TRTR = $800,000/ $68,000 = 11.76
III. Interpreting the results
Calculating the TRTR is not enough; you have to analyze and interpret the results properly. Here are a few ways you can interpret the Trade Receivables Turnover Ratio correctly-
A. Ideal TRTR range for businesses
Knowing the positive TRTR range is essential to understanding whether the result is good for you or not. A TRTR range of 7.8 and above is considered positive for businesses across different industries. However, it can slightly vary based on market conditions, sector, number of competitors, and more.
B. Implications of a high or low ratio
A high ratio suggests the company has a conservative credit policy, such as a net 10-day or 20-day policy. A low TRTR suggests that the company has a poor collection record.
C. How industry norms play a role
Industry norms play a crucial role in TRTR. For example, the manufacturing industry no longer has credit cycles, so a low TRTR is not a concern in this sector when it comes to growth or getting more investors.
V. Strategies for improving TRTR
Improving your TRTR is essential for financial stability and growth. Here are a few ways you can do so.
A. Efficient credit management
The first and foremost important strategy to improve your Trade Receivables Turnover Ratio is to manage your credit efficiently. When you manage your credits efficiently and within the targeted time frame you can witness increased TRTR instantly.
B. Timely collections
Another good financial habit or strategy to follow to improve your trade or account receivables turnover is to collect your credit in a timely manner. Make policies to boost timely collections.
C. Building strong customer relationships
Lastly, building a strong and healthy relationship with your customers and investors is also helpful in improving your TRTR. Because fostering a healthy relationship will eventually lead to timely payoffs of the credit you/your company owes to them.
VI. Real-world applications
The trade or account receivables turnover ratio is a simple calculation. It represents a company’s ability to turn its account receivables into cash within a specific period. With real-world examples, you will get a better understanding of this financial metric.
A. Case studies showcasing TRTR in action
The latest balance sheet of Coca-Cola India can help to see TRTR in action.
| The fiscal year is January–December. All values USD Millions. | 2023 | 2022 |
| Cash and Short-Term Investments | 13,663 | 11,631 |
| Cash Only | 9,366 | 9,519 |
| Cash and Short-Term Investments Growth | 17.47% | -7.87% |
| Cash and ST Investments / Total Assets | 13.98% | 12.54% |
| Total Accounts Receivable | 3,410 | 3,487 |
| Accounts Receivables, Net | 3,410 | 3,487 |
| Accounts Receivables, Gross | 3,912 | 4,003 |
| Bad Debt/Doubtful Accounts | (502) | (516) |
| Accounts Receivable Growth | -2.21% | -0.71% |
| Accounts Receivable Turnover | 13.44 | 12.29 |
B. Lessons learned from successful implementations
When the Trade Receivables Turnover Ratio is calculated and maintained appropriately, it not only helps to increase cash flow and liquidity but also boosts financial stability, reduces bad debts, and strengthens the company’s financial health. It ultimately reflects in the company balance sheet, attracting more investors and expanding trading horizons.
C. Pitfalls to avoid
TRTR is indeed a highly useful tool in evaluating a company’s ability to manage account receivables. However, there are several pitfalls to avoid. For example, using total sales instead of the net sales of a company during TRTR calculation leads to inaccuracy. Doing so would suggest that the company has a higher TRTR than it in fact does.
VII. Conclusion
TRTR or Trade Receivables Turnover Ratio is also known as the account receivables turnover ratio. This financial metric has a deep connection with the company’s financial health. It helps to evaluate the efficiency of a company in turning its accounts receivable into cash within the time frame of one year or less than one year. TRTR has a close link with cash flow and liquidity.
The formula of TRTR is simple and real-world examples can offer a more vivid understanding of the formula. Here, we have presented a brief guide to trade or account receivables turnover ratio for your help.
Remember trade receivables turnover ratio is a very important financial metric in the business world. It plays a pivotal role in evaluating the financial status and stability of a company.
Financial stability is important for a company to grow and attract more investors. One can assess and ensure it by evaluating the account receivables turnover ratio. On the other hand, investors must evaluate a company’s TRTR to ensure it is a good investment. So, whether you are a finance enthusiast, investor, or business professional, investing your time in TRTR is essential for financial stability and growth.
FAQs
1. What is the average age of account receivables?
Most companies collect their trade account receivables within 30 days. The average age of trade receivables can thus be 35 to 36 days.
2. How is the trade receivable turnover ratio calculated?
The trade receivable turnover ratio is calculated by using average account receivables to divide net annual credit sales for a certain timeframe.
3. What is a good TRTR?
A good Account Receivable Turnover Ratio can vary from one industry to another. However, 7.8 and above is considered good in general.
4. What is the importance of the Trade Receivable Turnover Ratio?
The efficiency of a company’s credit collection process can be measured by the account receivable turnover ratio also, how it manages its cash flow and other financials.
