Essay Writing Help on Account Receivable Turnover

Account Receivable Turnover

Definition

Account Receivable Turnover (A/R Turnover) is a measure of a company’s capability to give credit to its customers and collect revenue from such funds over a given period. The company’s annual sales and its mean balance in the Accounts Receivable determine the ratio.

Components of the Cash Conversion Cycle

A Cash Conversion Cycle is the measurement of the number of days a firm’s cash is used in production and sales as well as the amount used to pay its creditors. There are four components used in the calculation of the Cash Conversion Cycle. These are:

  • Days Inventory Outstanding (DIO)

DIO is a ratio that shows the number of days a firm keeps its inventory before selling it. It usually indicates whether the firm is making profit or incurring bad losses. For example, a decreasing ratio of the sale of the machinery of a company indicates a rise in the level of sales, whereas an increasing ratio indicates that the company is making bad losses. It is calculated by multiplying the number of days in a year by the average inventory.

  • Days Sales Outstanding (DSO)

This is the number of days that a firm takes to collect its revenues from the sales of goods and services. A company that takes a long time to collect its revenues usually has more creditors, and therefore, high DSO; otherwise, a company with low DSO will take a short period of time to collect its revenues.

  • Days Payables Outstanding (DPO)

DPO is the period a company takes to pay its creditors such as suppliers. The DPO is computed annually or quarterly. To calculate the DPO, the Number of Days or Cost of sales divides the ending accounts payable in a given year.

Working capital is the level of capital a company needs in its day-to-day activities. To calculate the amount, the three mentioned components of the Cash Conversion Cycle are considered.

Reasons why companies give Trade Discounts

Trade discount is where the manufacturer or a wholesaler reduces the price of a good to a retailer. Trade discounts are advantageous to both the manufacturers and the retailers. For instance, through trade discounts, a retailer is likely to reduce the costs of running the firm since most of their capital is directed towards raw materials, and acquire machineries and other operational equipment. Secondly, trade discounts improve the power of purchase since the retailers are able to make good profits that enable them buy goods in bulk. In addition, trade discounts also improve the goodwill of the manufacturing companies; for instance, a company that sells quality goods and services at low prices is likely to attract more customers and at the same time build ample environment for its operations. Moreover, trade discounts, especially the promotional sales, coupons, and volume buying attracts more customers to the company.

Why Trade Discounts are not recorded in Books of Accounts.

Books of accounts comprise a list price; however, a trade discount involves a reduction in the price of the good and service as per the agreement between the parties involved. Such sales are not recorded because they do not match the listed prices. The purchaser therefore takes care of the invoiced price. Furthermore, not all customers receive trade discount and therefore leading to difference in the prices recorded in the books of accounts.