Debtors Turnover Ratio | Accounts Receivable Turnover Ratio:
A concern may sell goods on cash as well as on credit. Credit is one of the
important elements of sales promotion. The volume of sales can be increased by
following a liberal credit policy.
The effect of a liberal credit policy may
result in tying up substantial funds of a firm in the form of trade debtors (or
receivables). Trade debtors are expected to be converted into cash within a
short period of time and are included in current assets. Hence, the liquidity position
of concern to pay its short term obligations in time depends upon the quality of
its trade debtors.
Debtors turnover ratio or accounts
receivable turnover ratio indicates the velocity of debt collection of a firm.
In simple words it indicates the number of times average debtors (receivable)
are turned over during a year.
Formula of Debtors Turnover Ratio:
Debtors Turnover Ratio = Net
Credit Sales / Average Trade Debtors
The two basic components of accounts receivable
turnover ratio are net credit annual sales and average
trade debtors. The trade debtors for the purpose of this ratio include the
amount of Trade Debtors & Bills Receivables. The average receivables are found
by adding the opening receivables and closing balance of receivables and
dividing the total by two. It should be noted that provision for bad and
doubtful debts should not be deducted since this may give an impression that
some amount of receivables has been collected. But when the information about opening and closing balances of trade debtors
and credit sales is not available, then the debtors turnover ratio can be
calculated by dividing the total sales by the balance of debtors (inclusive of
bills receivables) given. and formula can be written as follows.
Debtors Turnover Ratio = Total
Sales / Debtors
Credit sales $25,000; Return inwards $1,000; Debtors $3,000; Bills
Calculate debtors turnover
Debtors Turnover Ratio = Net Credit Sales / Average
= 6 Times
less 1000 return inwards,
plus 1000 B/R
Significance of the Ratio:
Accounts receivable turnover ratio or debtors
turnover ratio indicates the number of times the debtors are turned over a year.
The higher the value of debtors turnover the more efficient is the management of
debtors or more liquid the debtors are. Similarly, low debtors turnover ratio
implies inefficient management of debtors or less liquid debtors. It is the
reliable measure of the time of cash flow from credit sales. There is no rule of
thumb which may be used as a norm to interpret the ratio as it may be different
from firm to firm.