Trade Receivables Turnover (Days)

This section explains how to calculate and interpret the trade receivables turnover ratio, specifically focusing on the 'days' component. This ratio helps assess how efficiently a business collects its debts from customers.

What is the Trade Receivables Turnover Ratio?

The trade receivables turnover ratio measures how many times a company collects its average accounts receivable (money owed by customers) during a specific period, usually a year. A higher ratio generally indicates that the company is efficient in collecting its debts.

Calculating the Trade Receivables Turnover Ratio (Days)

The ratio in this context is calculated as follows:

$$ \text{Trade Receivables Turnover (Days)} = \frac{365}{ \text{Trade Receivables (Average)} \times \text{Days Sales Outstanding (DSO)} }$$

Where:

• Trade Receivables (Average): This is the average amount of money owed to the company by its customers during the period. It is typically calculated by adding the opening and closing balances of accounts receivable and dividing by 2.
• Days Sales Outstanding (DSO): This represents the average number of days it takes for a company to collect payment from its customers. It is calculated as: $$ \text{DSO} = \frac{\text{Average Accounts Receivable}}{\text{Credit Sales}} \times 365 $$

Steps to Calculate the Ratio

1. Calculate the Average Accounts Receivable: $$ \text{Average Accounts Receivable} = \frac{\text{Opening Accounts Receivable} + \text{Closing Accounts Receivable}}{2} $$
2. Calculate the Days Sales Outstanding (DSO): $$ \text{DSO} = \frac{\text{Average Accounts Receivable}}{\text{Credit Sales}} \times 365 $$
3. Calculate the Trade Receivables Turnover (Days): $$ \text{Trade Receivables Turnover (Days)} = \frac{365}{\text{Average Accounts Receivable} \times \text{DSO}} $$

Interpreting the Trade Receivables Turnover (Days) Ratio

The interpretation of this ratio depends on the industry and the company's specific circumstances. However, here are some general guidelines:

• High Ratio (e.g., less than 30 days): This suggests the company is efficient at collecting its debts. Customers are paying relatively quickly. This is generally a positive sign.
• Low Ratio (e.g., more than 60 days): This indicates that the company is struggling to collect its debts. Customers are taking a long time to pay. This could lead to cash flow problems.
• Comparison to Industry Average: It's important to compare the company's ratio to the average for its industry. This provides a better understanding of its performance relative to its competitors.

Example Calculation

Assume a company has:

• Opening Accounts Receivable: $10,000
• Closing Accounts Receivable: $12,000
• Credit Sales: $100,000

Calculation:

1. Average Accounts Receivable = ($10,000 + $12,000) / 2 = $11,000
2. DSO = ($11,000 / $100,000) x 365 = 40.15 days
3. Trade Receivables Turnover (Days) = 365 / ($11,000 x 40.15) = 8.72 days

Interpretation: The company collects its debts in approximately 8.72 days. This is a relatively high turnover, suggesting efficient collection practices.

Table Summary

Ratio	Formula	Interpretation
Trade Receivables Turnover (Days)	$$ \frac{365}{\text{Average Accounts Receivable} \times \text{DSO}} $$	Indicates the average number of days it takes to collect money owed by customers. A lower number is generally better.