I am applying for a business loan and the lender is scrutinizing every aspect of my business. He just asked for my Accounts Receivable Turnover. Is he digging too deep?
--Name withheld at request
Accounts Receivable Turnover (ART) is a measure of the frequency of payment on accounts receivable, the money owed to you by your customers you are waiting to "receive."
The lender is simply taking a close look at one of the factors that affects cash flow. In effect a credit sale is like a loan, so the lower the ratio the more slowly your customers are paying off the loans you make to them; the higher the ratio, the more quickly you're being paid.
How fast are you getting paid?
Here's the formula: ART = net credit sales / average accounts receivable
For example, say last year your net sales were $200,000. You don't take payment by credit card; you send invoices. The average, at any given time, of your outstanding receivables was $50,000.
200,000 / 50,000 = 4, so your Accounts Receivable Turnover is 4.
If your customers purchase goods or services through a purchase order, or you send invoices, the money you are owed is considered a receivable. If you're a consultant and you perform a service and bill the client later, the bill is a receivable--it is money you are owed but have not been paid.
But a credit card sale is not "credit" for the purposes of this metric; while the customer is using credit to make the purchase, you get paid right away (roughly speaking.) The credit card company extends the credit, meaning that's a receivable for it, not you. So don't include credit card sales in your net sales, at least for the purpose of this metric.
So, two main factors affect your ART: Your payment terms and whether your customers meet those terms. You may ask for payment on receipt, or within 15 days, or 30 days--whatever makes sense for your business, offset by customer expectations. If your terms are too tight some customers may find another vendor willing to offer more generous terms.
Many companies set payment terms of net-30, which means 30 days from the invoice date. Others set terms of 15 days, seven days, or even "on receipt."
Of course, if you specify net-seven and expect payment within seven days of receipt of invoice, the entire process typically takes longer: It may take you several days to generate the invoice, then another day or two to actually process the payment and make a deposit... all of which increases your ART.
You can do several things to increase your ART:
- Shorten your credit terms, say from net-30 to net-15
- Require initial deposits to reduce the total amount of credit extended
- Improve your billing efficiency so invoices are generated and sent as quickly as possible
- Create incentives for rapid payment of invoices
- Work to shift more customers, especially new customers, to pay by credit card or bank transfer. (Sometimes this is as easy as saying, "How would you like to pay: by credit card or wire transfer?")
Keep in mind ART does not exist in a vacuum. Say you take credit card payments and fees are 3% of sales; if you can receive check payments within seven days from the majority of your customers, building in an intentional receivable delay may more than offset the fees you would be charged by the credit card company.
So if your ART is relatively high because you've made smart business decisions, walk your lender through that analysis. If it's low, work to get paid more quickly.
Even if you don't get the loan, raising your ART will help your business.