Are you tired of waiting for your clients to pay up? As a construction business owner, managing your accounts receivable (AR) can be a constant headache. You want to ensure that you are collecting payments on time, but it can be challenging to determine if you are doing it efficiently. That is where your accounts receivable turnover ratio (ART) comes in.
In this blog post, we will cover what ART is, how to calculate it, and what a good ratio looks like. But that's not all—we will also dive into the Collection Effectiveness Index (CEI) and explain how it differs from ART. And if you're looking to supercharge your AR turnover ratio, we've got three game-changing ways an automated workflow can help. Trust us, you won't want to miss this!
Table of Content:
What is Accounts Receivable Turnover?
In the construction industry, contractors usually provide services before getting paid. They send invoices and give clients time to pay, making cash flow management tricky. To keep track of the money owed, we use "Accounts Receivable."
We use a ratio called Accounts Receivable Turnover (ART) to see how quickly clients pay. The higher the ART, the faster the business gets paid. This helps credit managers see if their credit policy and collection efforts work well.
Think of it like this: if you lend your friend some money, you want them to pay you back as soon as possible. The ART ratio helps businesses see how quickly they're getting paid, so they can make sure they're not waiting too long for their money.
What Is a Good Accounts Receivable Turnover Ratio?
When it comes to collecting debts, a high accounts receivable turnover ratio is like hitting the jackpot. It means you're doing a great job of getting your money back. But what's considered a "good" ART ratio can vary depending on your business and industry.
For example, in the construction industry, a good ART ratio is typically between 4 and 6 per year. This means that clients pay their debts four to six times a year, which is pretty good! Just remember, the size of your business and payment terms can also affect your ART ratio. Therefore, no standardized ratio distinguishes a "good" AR turnover ratio from a "bad" one.
Should the AR Turnover Ratio be High or Low?
A high accounts receivable turnover ratio indicates that a business collects payment from its clients quickly. This is generally a good sign because it means that you are efficiently having cash coming in.
On the other hand, a low ART ratio indicates that a business is taking longer to collect payments from its clients. This could be a sign of poor cash flow management, which could lead to financial difficulties.
ART vs. CEI: Which One Tells You How Efficiently You're Collecting Your Money?
Accounts Receivable Turnover and Collection Effectiveness Index are both tools for measuring how well a business is managing its accounts receivable, but they approach it from different angles.
ART tells you how many times per year you collect outstanding debts from your clients. On the other hand, the CEI measures the percentage of the debt you've actually collected during a specific period.
So, for instance, if your ART ratio is 5, that means you're collecting outstanding debts five times per year. But a CEI of 90% tells you that you've collected 90% of the debts you were owed, no matter how many times you actually collected payment.
How to Calculate Accounts Receivables Turnover (Step-by-Step)
Calculating your ART ratio is easy. You can find all the information you need on your financial statements, including your income statement and balance sheet. Then, follow these steps:
Step 1: Determine net credit sales.
Net credit sales are the total amount of sales made on credit during a specific period. This can be done by subtracting sales returns and allowances from all sales on credit.
The formula for net credit sales is as follows:
Step 2: Calculate your average accounts receivable.
This is the total amount of accounts receivable at the beginning and end of a time, divided by two.
The formula for average accounts receivable is as follows:
Step 3: Calculate the accounts receivable turnover ratio
To calculate your ART ratio, divide your net credit sales by your average accounts receivable.
The accounts receivable turnover formula is as follows:
For example, a ratio of 4 means you collect average receivables four times per year. Want to get paid on time and manage your cash flow better? Aim for a high accounts receivable turnover ratio!
The higher the ratio, the more efficient you are at collecting debts. QuickBooks recommends a ratio of around 12 if your credit policy requires payment within 30 days.
Boost Your AR Turnover Ratio with Automated Workflow: 3 Key Benefits
Want to improve your ART ratio? An automated AR workflow could be the solution. Here are three benefits it can help with:
Slash the time it takes to process invoices and payments, speeding up collections and keeping cash flowing in.
Get a clear view of your AR processes, so you can spot any issues and fix bottlenecks or delays.
Increase accuracy and reduce errors in invoicing and payment processing, leading to fewer disputes and stronger client relationships.
Managing accounts receivable can be a headache for construction business owners. But with the accounts receivable turnover ratio (ART), you can determine if you're collecting payments efficiently.
And to supercharge your ART ratio, an automated workflow can help. At CCA, we specialize in bookkeeping services for construction businesses and can help you set up an automated A/R workflow to improve your cash flow. Don't wait any longer to get paid on time - contact us today!