# Debtors Turnover Ratio: Meaning, Formula, Examples

Last updated:

Efficient management of working capital is crucial for the success of any business. And a key financial metric that helps companies with the same is the debtors turnover ratio. Let's understand what debtors turnover ratio means and learn how it is calculated using a formula via this article. Read along to also get an idea of the significance of this ratio in financial analysis.

## What is the Debtors Turnover Ratio?

'Debtors Turnover Ratio' is also called 'Accounts Receivable Turnover Ratio.' It is a core financial metric used to assess how fast a company collects its customer debts. This little number measures how well a company converts credit sales into cash. A higher debtor turnover ratio indicates a shorter collection cycle. On the other hand, a lower ratio suggests an opposite process, meaning the company might have some cash flow problems.

That is why this ratio is vital for investors, too, for understanding a company's liquidity and cash flow health.

## Debtor Turnover Ratio: Formula and Calculation

Let's analyze a company's credit collection efficiency for a fiscal year.

## Stats

• Net Credit Sales: ₹3,20,000
• Beginning Accounts Receivable: ₹75,000
• Ending Accounts Receivable: ₹1,10,000

## Calculation

Average Accounts Receivable = (Beginning Accounts Receivable + Ending Accounts Receivable) / 2

= (₹75,000 + ₹1,10,000) / 2

= ₹92,500

So, Debtor Turnover Ratio = Net Credit Sales / Average Accounts Receivable

= ₹3,20,000 / ₹92,500

= 3.46 (approx)

Here,

• Net Credit Sales is the total amount the company earned from selling goods or services on credit, minus any products that were returned;
• Average Accounts Receivable is the amount customers owe the company at any given time. Basically, the mean of the opening and closing balances of accounts receivable within a specific timeframe.

## Explanation

This company's debtors turnover ratio of approximately 3.46 shows that its credit sales are converted into cash roughly every 3.46 months.

## Limitations of the Debtors Turnover Ratio

The debtors turnover ratio, while useful, has several drawbacks:

1. It only measures accounts receivable efficiency and does not give a complete picture of a company's financial health.
2. Accounts receivable fluctuate throughout the year, so using an average of the beginning and ending values may not accurately reflect true performance.
3. This ratio must be interpreted within the context of the specific industry. In sectors with irregular revenue streams, a low debtors turnover ratio may not indicate a problem.

## Conclusion

Businesses must monitor the debtors turnover ratio to safeguard cash flow. Analyzing this ratio helps identify collection issues and allows for proactive steps. These steps might involve revising credit terms or strengthening collection procedures.

Furthermore, comparing the ratio to industry benchmarks provides valuable context. Effective management of the debtors turnover ratio empowers businesses to optimize accounts receivable and solidify their financial position.

Share: