Receivables Management Overview

The primary goal of receivables management is to quickly recover receivables while maintaining as positive a relationship as possible with your customers. Tight credit policies and overly aggressive collections may turn your receivables into cash more quickly, but if they cost you business in the long run it doesn't matter much. The key is to strike a balance.

Receivables Turnover Ratio

We'll start by looking at a few key ratios to measure our receivables management program. It may be helpful to review our previous section on Working With Basic Financial Ratios if you are not familiar with financial ratios.

The receivables turnover ratio is an important ratio that measures how many times receivables are turned over during the year. The ratio is below.

Accounts Receivable Turnover = Credit Sales / Average Receivable Balance

Simply take the amount of credit sales and divide by the average receivables balance over the same period. This ratio is often applied to a full year of financial records. The higher the ratio, the faster your company is able to convert receivables into cash. If the result is 7.6, that means that your company turns receivables into cash 7.6 times throughout the year.

Companies with low receivables turnover ratios may need to reevaluate the credit policies and collection strategies.

Number of Days In Receivables

The ratio below will is based off of the receivables turnover ratio and gives the average number of days it takes to turn receivables into cash. This makes the measure easier to understand and manage throughout the organization.

Number of Days in Receivables = 365 Days in the Year / Turnover Ratio

This will result in a figure like 35 days or 42 days. This makes the figure easier to communicate.

Both of these ratios establish an important baseline for the rest of this course. We can't measure what we can't manage.

Customer Relationships

Throughout this course we will be providing strategies to optimize the ratios above, and turn receivables faster. However, it is also important to understand that strong customer relationships can be one of the most effective methods of improving a receivables management program. Customer relationships help to alleviate any general frustration with the collections process, and often result in faster payment. It's much easier for a customer to pay a company that they like doing business with.