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The accounts receivable turnover ratio is a type of activity ratio—that is, an indicator of how efficient a company is operating— used to assess a company’s effectiveness in managing its credit policy. The accounts receivable turnover ratio also indicates how quickly credit customers pay their invoices. The accounts receivable turnover ratio is determined by dividing the net credit sales of a company by the average accounts receivable over the same time period. A high accounts receivable turnover ratio is an indication that the company’s collection efforts are well managed and enforced. If the accounts receivable turnover ratio is low, the company’s credit policies may need to be tightened in order to maintain the receipt of revenue from credit sales. The accounts receivable ratio is useful in determining the type of credit to offer customers and which clients should be eligible for an account with your business. There is a big opportunity cost involved with providing credit to your clients. When goods or services are delivered without immediate payment, there is a threshold at which the benefit of the sale loses worth against the need for immediate cash inflows. The accounts receivable turnover ratio can help display this threshold by quantifying the success with which your business conducts its sales and collections program. The accounts receivable ratio is not a tool that reveals decisive patterns or a technique to resolve conflicts. Rather, it is an instrument to help you better understand the model that should be followed to guarantee that accounts receivable are being used to their full potential.
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