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Financial ratios are a specific set of management tools a company can use to assess its operations. Return on turnover can apply to numerous ratios under the asset turnover group. These ratios provide information on how efficiently a company uses the assets owned to generate revenue or collect cash owed by customers. Ratio examples in the return on turnover section include formulas that involve accounts receivable or inventory. Other items may fall under this section, though these two groups are the most common measured with turnover ratios.
Accounts receivable return on turnover details information on how well a company collects cash from customers. Companies often sell goods on account, giving customers a number of days to pay for goods or services purchased. Accountants review financial information relating to the company’s accounts receivable. The information typically comes from the balance sheet, a financial statement prepared at each month end. The ratios here include receivables turnover and average collection period.
The receivables turnover ratio divides credit sales by accounts receivable. The ratio can use either monthly or annual financial data. The ratio result indicates how many times the company collected it s entire accounts receivable balance each period. A higher number is preferable as this typically indicates that a company is very efficient at collecting monies owed. Lower numbers are the result of poor collection procedures or companies extending credit to customers who cannot pay future bills.
Average collection period details how many days it takes to collect open accounts receivable. Accountants divide 365 — the number of days in a year — by the receivables turnover ratio result. This provides information on the number of days it takes to collect open accounts receivable. These two ratios combined provide information on the return on turnover specifically related to accounts receivable.
Inventory return on turnover ratios are similar to accounts receivable turnover ratios. Dividing cost of goods sold by average inventory produces a figure for how many times a company sells through its inventory in a given period. Again, higher numbers are preferable as higher inventory sales indicate more efficiency at generating sales and earning cash. Inventory sales can result in accounts receivable, creating a distinct link between these return on turnover ratios.
The second inventory turnover ratio divides 365 by inventory turnover, similar to the average collection period. The result is how many days a company will turn over inventory in a specific period. Lower numbers indicate it takes fewer days to sell through inventory, often a plus for a company. These two inventory ratios together provide a good look at a company’s inventory accounting and management processes.