Why Receivables Returns Matter to Investors
Investing Lesson: Analyzing a Balance Sheet
For companies to be successful, it's important to have customers pay for things on time. When customers purchase goods or services on credit and then pay quickly, companies are usually in better shape financially. They can put cash in the bank, pay down debt, or use the money to start making new products.
When analyzing the balance sheet, investors can calculate how quickly customers are paying their credit bills, and this can offer insight into the health of the organization.
Receivable Turns Calculation
The receivable turns or accounts receivable turnover is a great financial ratio to learn when you are analyzing a business or a stock because common sense tells you the faster a company collects its accounts receivables, the better. Fortunately, there is a way to calculate the number of days it takes for a business to collect its receivables. The formula looks like this:
Credit Sales1 ÷ Average Accounts Receivables = Accounts receivable turns
(1) Credit sales are found on the income statement, not the balance sheet
Take a look at an example. The table at the bottom of this page will provide you with the numbers you need for a fictional company, H.F. Beverages.
An Example of Calculating Receivable Turns
H.F. Beverages is a major manufacturer of soft drinks and juice beverages. It sells to supermarkets and convenience stores across the country and offers its customers 30-day terms, which means the customers have 30 days to pay for the beverages they've ordered to resell.
To see if customers are paying on time, you need to look for the income statement. It is normally found within a page or two of the balance sheet in a company's annual report or 10K. With the income statement in front of you, look for an item called "Credit Sales" (if you can't find it, you can use total sales which is acceptable, but not as accurate).
In 2009, H.F. Beverages reported credit sales of $15,608,300. It had $1,183,363 in receivables in 2009, and in 2008, it reported receivables of $1,178,423.
Find out the average amount of receivables H.F. had in 2009 by adding the two receivables numbers ($1,1873,363 + $1,178,423) and dividing by 2. This results in average accounts receivable of $1,180,893.
Now plug the two numbers into the receivable turn formula:
Credit Sales of $15,608,300 ÷ Average Receivables = $1,180,893
The answer, called receivable turns by financial analysts and professional investors, is 13.2173. This means that H.F. Beverages collects its accounts receivable 13.2173 times per year.
Once you calculate this number, finding out the number of days it takes for customers to pay their bills is simple. Since there are 365 days in a year and the company gets 13.2173 turns per year, take 365 ÷ 13.2173. The answer is the number of days it takes the average customer to pay (in H.F.'s case, you should come up with 27.61).
Interpreting the Result
This means the company is doing a good job managing its accounts receivable because customers aren't exceeding the 30-day policy. Had the answer been greater than 30, you would have been wise to try to find out why there were so many late-paying customers, which could be a sign of trouble.
Keep in mind you will need to read through the company's reports to find out what its collection deadline is. Not all companies require their customers to pay within 30 days.
Sample Receivable Turns Calculation Data
H.F. Beverages Financial Statement Excerpt: