IGCSE Trade Receivable Turnover Analysis
In this lesson, we will learn how to calculate and interpret the trade receivables turnover ratio and compare trade receivables management performance across different years of the business, and with other businesses.
Related Lessons:
Purpose of Trade Receivable Management
Trade receivable management is important as goods or services have been transferred to the customers but cash from these sales has yet to be received. Debts not collected back on time reduces the business cash flow which leads to poor liquidity.
Efficient trade receivable management means the business is able to:
- maintain it sales
- extend credit to customer who are credit-worthy
- have an effective collection policy
Calculation & Interpretation
Trade receivable turnover days measures the number of days a business takes to collect its debts back from trade receivables after the sales.
To calculate, we take Closing Trade Receivables divided by Credit Sales and multiply the answer by 365 days.
(Closing trade receivables / Credit sales) x 365 days = x days
A short trade receivable turnover day means that the business is collecting its debts back on time. The business may have:
- Effective collection policy
- Strong credit control
- Extended credit only to credit-worthy customers
This situation is preferred as it increases cash flow thus liquidity and reduces expenses such as irrecoverable debts and administrative costs.
A long trade receivable turnover day indicates that the business is taking a longer time to collect its debts, therefore less frequent collection during the year.
Possible causes include:
- Ineffective collection policy
- Lenient credit policy
- Weak credit control, extending credit to less credit-worthy customers
This results to a decrease in cash flow and profit due to high uncollectible debts and administrative cost.
To improve, the business may:
- Gives cash discount to reward prompt payment
- Impose late payment charges
- Perform more checks on customers before extending credit to them