Accounting: what is turnover???

hampster
Fri, 28 Nov 2008 12:48:13 +0000

I just read through that portion of my managerial accounting class without thinking much about it. Anyway, here is how I understand the ratio (I admit I forgot it and had to look it up again):

Okay, let’s assume that every single one of your sales were credit sales, that is sales on account or non-cash sales. Alright, let’s say the denominator, the “average accounts receivable balance for the year,” is very small and the numerator, your credit sales is large.

Now, how can this be? If all of your sales are on credit, one would normally think that your account receivable balance should be really big right? The only explanation is that you are good at collecting cash from your customers. Hence, this is the reason why your average accounts receivable balance is small.

So, the bigger your sales on account, we expect a normal business to also have a bigger average accounts receivable balance. If it’s really small, then it means that you’re good at getting the cash.

The higher the sales on account (the numerator) and the lower the average accounts receivable balance (the denominator),

the greater your accounts receivable turnover.

Hope this makes sense. Please let us know what your prof said. Also, what textbook are you guys using?

*Edit: I re-read your post again and realized I didn’t get at the heart of what you’re asking. Now that I think I understand what you’re saying, I honestly don’t know the answer. You mentioned dividing the accounts receivable turnover into 365 days. That’s actually a separate ratio called the average collection period. This is the formula:

Average Collection Period: 365 days/Accounts Receivable Turnover.

This ratio tells you the average number of days it takes a business to collect an account.

However, what I don’t understand, and I assume this is what you’re getting at, is what exactly does the accounts receivable turnover mean as a denominator in the context of this formula. I think of the A/R turnover as a crude proxy for how good the business is at collecting on an account, but I don’t know what it means precisely when you divide it into 365 days.

I’ll ask my prof. next week.