Usage of Debtors or Receivables Turnover Ratio and Collection Ratio

Isn't interesting to know how the recent credit services works in eveluating debtors finance? Most finance professional nowadays refer to Debtors turnover ratio. There are different approach to see debtors in terms of days of sales, Debtors Collection ratio or Debtors Sales Outstanding (DSO) comes into picture. Lets see here in detail.

BACKGROUND

In present times most of the business run on credit to its customers, without which its very difficult to have business. For maintaining credit to its customer, every business to decide:

• How much credit organisation can allow to customer
• How much credit presently appearing in books
• What are controls expected to align credit

To anwser these questions, every organisation to look its Debtors/Receivable Turnover Ratios or its Debtors collection Ratio, also referred as Debtors Sales Outstandings.

DEBTORS TURNOVER RATIO

Debtors’ turnover ratio can be calculated by dividing the net value of credit sales during a given period by the average accounts receivable during the same period. Average accounts receivable can be calculated by adding the value of accounts receivable at the beginning of the desired period to their value at the end of the period and dividing the sum by two.

The method for calculating debtors turnover ratio can be represented with the following formula:

Debtor Turnover Ratio = Total Turnover / Average Accounts Receivable

The Debtors turnover ratio is most often calculated on an annual basis, though it can also be calculated on a quarterly or monthly basis.

Debtors’ turnover ratio is also often also called as receivable turnover and accounts receivable turnover ratio.

Larger Debtor Turnover ratio represent less account receivables and Smaller debtor turnover ratio shows increased level of Debtors. Hence Larger value of this ratio is desired by management or stakeholders.

DEBTORS COLLECTION RATIO / SALES OUTSTANDING

Its a different reperesentation of debtors, where it says how much days sales is outstanding to collect from debtors. i.e.,

Debtor Sales Outstanding (DSO) = Average Accounts Receivable / Total Turnover X 365 Days or Average Accounts Receivable / Daily Sales

Example

Sales / Turnover - INR 365 Lacs for the period
Debtors Opening - INR 50 Lacs, closing - INR 60 Lacs
Average Debtors = INR (50+60)/2 = 55 Lacs

Debtors Turnover Ratio = Sales INR 365 / Debtors INR 55 = 6.64 Times

Daily Sales Outstanding = Debtors INR 55 Lacs / Sales 365 Lacs X 365 Days = 55 Days

It means, 55 days of sales in outstanding at present for the organisation, i.e., funds will be blocked for 55 days of average sales. So organisation can plan its increase of sales / budget along with funds availability for blocking of funds in Debtors.

CONCLUSION

If we see above example, debtors turnover ratio of 6.64 times says, sales is 6.64 times of its debtors, and Debtors sales outstanding says its 55 Days, which means organisation need generally 55 days to collect the cash from its debtors after sales.

Different industries has different standards of such ratios, if there is service industries, organisation may feel good to have DSO near 40/50 Days, and in case of manufacturing industry, may look for it being less than 30 days.

There are few businesses, where most of sales on cash basis, where such challenge to maintain control on debtors does not exits, but most of businesses require it, because blockage of funds means extra costs on Cash Credit limits to bank, borrow of funds from bank to meet vendors payments / expneses.

**So every business to see regularly its revenue vs debtors ratio, and seek immediate measures to control to possible extent, such as:

• review of its credit policy
• offering discount for payment within due dats
• implementing dunning charges on delay payments
• bill discounting facilities
• prefer use of letter of credits/ bank guarantees etc

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