Trade Receivables Turnover (Days)

This section explains how to calculate and understand the trade receivables turnover ratio, specifically focusing on the 'days' component. This ratio is a crucial indicator of how efficiently a business collects its debts from customers.

What is Trade Receivables?

Trade receivables represent the money owed to a business by its customers for goods or services that have been delivered but not yet paid for.

What is the Trade Receivables Turnover Ratio?

The trade receivables turnover ratio measures how many times a company collects its average accounts receivable balance during a period (usually a year). A higher ratio generally indicates that the company is collecting its debts quickly.

Calculating Trade Receivables Turnover (Days)

The trade receivables turnover ratio is often expressed in 'days'. This indicates the average number of days it takes for a company to collect payment from its customers.

The formula is:

$$ \text{Days in Receivables} = 365 \div \text{Trade Receivables Turnover} $$

Alternatively, if you have the average trade receivables balance:

$$ \text{Days in Receivables} = \frac{365}{\frac{\text{Average Trade Receivables}}{\text{Cost of Goods Sold}}} $$

Where:

• Trade Receivables Turnover: $$ \frac{\text{Cost of Goods Sold}}{\text{Average Trade Receivables}} $$
• Average Trade Receivables: $$ \frac{\text{Opening Trade Receivables} + \text{Closing Trade Receivables}}{2} $$
• Cost of Goods Sold: The direct costs attributable to the production of the goods sold by a company.

Understanding the Ratio

The 'days' figure provides a clear understanding of the collection period. Here's how to interpret different values:

• Low Days (e.g., less than 30 days): This is generally considered good. It suggests the company is efficient at collecting its debts and has a healthy cash flow.
• Medium Days (e.g., 30-60 days): This is a typical collection period for many businesses.
• High Days (e.g., more than 60 days): This could indicate problems with credit control, slow-paying customers, or potentially risky credit policies. It might also suggest the company is being too lenient with credit terms.

Example Calculation

Suppose a company has a Cost of Goods Sold of £100,000 and an average Trade Receivables balance of £20,000.

1. Calculate the Trade Receivables Turnover: $$ \text{Turnover} = \frac{100,000}{20,000} = 5 $$
2. Calculate the Days in Receivables: $$ \text{Days} = \frac{365}{5} = 73 $$

This means it takes the company an average of 73 days to collect payment from its customers.

Table Summary

Ratio	Formula	Interpretation
Days in Receivables	$$ \frac{365}{\text{Trade Receivables Turnover}} $$	Average number of days it takes to collect payment from customers. Lower is generally better.
Trade Receivables Turnover	$$ \frac{\text{Cost of Goods Sold}}{\text{Average Trade Receivables}} $$	How many times a company collects its average accounts receivable balance during a period.