Day 7 of Fundamental Investing
We had a few email replies letting us know that we were going a little fast. Are we?
So henceforth, we'll go a little slower and let you digest the ratio a little more. Sounds good? Instead of learning 1 ratio a day, we'll take it one in 2 days.
Well, you know what they say: 'Slow and steady, wins the race.'
Continuing with our series, next up are Efficiency Ratios!
The first ratio is Acccounts Receivable Turnover Ratio.
What is it?
It’s an efficiency ratio or activity ratio that measures how many times a business can turn its accounts receivable into cash during a period. In other words, the accounts receivable turnover ratio measures how many times a business can collect its average accounts receivable during the year. A turn refers to each time a company collects its average receivables. If a company had $20,000 of average receivables during the year and collected $40,000 of receivables during the year, the company would have turned its accounts receivable twice because it collected twice the amount of average receivables.
How to calculate it?
Here's an image for the same:
What's its significance?
Since the receivables turnover ratio measures a business’ ability to efficiently collect its receivables, it only makes sense that a higher ratio would be more favourable. Higher ratios mean that companies are collecting their receivables more frequently throughout the year.
For instance, a ratio of 2 means that the company collected its average receivables twice during the year. In other words, this company is collecting is money from customers every six months.
Higher efficiency is favourable from a cash flow standpoint as well. If a company can collect cash from customers sooner, it will be able to use that cash to pay bills and other obligations sooner.
That's it for today!
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