What is a Debtors Turnover Ratio?
The debtors turnover ratio is a activity ratio that measures the efficiency of the receivable management to collect the amount due from debtors in due time.
It establishes relation between credit sales & its debtors. Liquidity position of the company and timing of collection of the management can also be revealed by the debtors turnover ratio.
Debtors turnover ratio is also called 'Account Receivables Turnover' ratio. In other words, it indicates how efficiently the management is able to implement Collection policy of the firm.
Debtors Turnover Ratio Formula
The debtors turnover ratio formula is as follows:
Debtors Turnover Ratio=(Net Credit Sales/Average Debtors)
Where, 'net credit sales' are sales where the cash is collected at a later date. So,the formula for net credit sales is total credit sales minus sales returns. We can find this in the P&L statement of the company.
'Average debtors' is the sum of opening debtors and closing debtors over a time period(it may monthly or quarterly) divided by 2.
Debtors Turnover Ratio Example
It is a ABC company. Here is some information about the ABC company.
Particulars Amount(Rs)
Credit sales 5,00,000
Sales returns 1,40,000
Opening debtors 40,000
Closing debtors 50,000
So, net credit sales=(5,00,000 - 1,40,00)
= 3,60,000
Average debtors=(40,000 + 50,000)/2
=45,000
Therefore, Debtors Turnover Ratio=(3,60,000/45,000)=8 times
It means that the company collects from its debtors 8 times a year.
What is the Debtors collection Period?
The debtors collection period refers the number of days required by the company to collect money from its debtors.
Debtors Collection Period Formula
The Debtors collection period formula is calculated by dividing 365 by debtors turnover ratio.
Debtors Collection Period=(365/Debtors Turnover Ratio)
Where, 365 days are taken for calculating the number of days.
Debtors Collection Period Example
Debtors Collection Period=(365/8)=45.62 days
It means that a company recovers its money from its debtors within 45.62 days.
The credit policy of the company states the number of days, a company allows its debtors to pay back. A stringent debtors policy would mean that the company collects its debts timely without any loss of interest cost but can also be a cause for potential loss of customers who are unable to pay within the credit period.
If the credit policy of the company is to collect debtors in 30 days, while on an average the company collects within 45.62 days, so it shows that the company is not able to collects from debtors within times, which may be due to inefficiency of collection process of the company. As the rule of thumb, the lower the number of days taken to recover from debtors, the better it is.
Debtors Turnover Ratio Interpretation
The debtors turnover ratio measures how many times in a given period the company receives cash from its debtors and customers.
The debtors turnover ratio and debtors collection period indicates that the credit policy of the firm. An efficiently run the company should strike the exact balance between the credit policy and the credit it extends to its debtors.
A higher ratio indicates the efficiency of the management regarding quick collection from its debtors or credit customers. quick collection of money from its debtors which indicates quick recovery of working capital and sound liquidity position of the company.
A lower ratio shows the inefficiency of the receivable management regarding collection from its debtors. A lower ratio also reflects slow in Collection policy results in delay in recovery of working capital and poor liquidity position of the company. Delay in collection policy shows the more blockage of working capital in receivables which results in more cost of funds and weak liquidity position of the company.
Generally, investors prefer higher debtors turnover ratio. A higher ratio indicates that the company collects cash more frequently. There is no ideal debtors turnover ratio. That is why compare companies within same sector and its competitors and find out a trend of past few years.
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