Sometimes referred to as accounts receivable turnover, "debtor turnover" is a term used to describe how quickly customers pay for goods and services purchased once those orders have been invoiced. Companies can use this information to determine if individual customers are routinely paying within terms or if the average amount of days it takes to receive a payment exceeds that amount. The same type of calculation can be applied to the entire customer base, providing valuable information about the rate of cash flow into the company from its generated sales. Typically, a debtor turnover that is at or near the payment terms extended on the invoices is considered healthy, while a turnover that exceeds those terms may be considered grounds for making some changes in how purchases by certain customers are handled.
There is some variation in how this ratio is calculated, based on what a company considers equitable payment terms. One simple example of how to calculate the debtor turnover ratio associated with an individual customer is to consider a client a standing monthly order for office supplies. The terms for the monthly ordwith ers are 30 days from receipt of invoice. Over the course of the year, that client will turn over or tender payment on a total of 12 invoices. By identifying the number of days after invoicing that it took to receive payment for each of those invoices, adding the totals together, then dividing by 12, it is possible to determine the debtor turnover for that annual period. Assuming that the turnover ratio is under 30 days, this would indicate a healthy cash flow situation for the company.
Calculating debtor turnover is a beneficial activity for businesses of all sizes. Doing so provides insight into how well the invoicing process is working in terms of getting accurate invoices out in a timely manner as well as how well the posting of receipts to the receivables is taking place. The calculation also aids in making sure the company’s payment terms are well understood by their clients, and that those terms are workable within the corporate culture that is applicable to the industry types that the company services.
Companies will normally engage in evaluating overall debtor turnover for shorter periods of time, often at least once per quarter. This approach works hand in hand with analyzing the aging of invoices, since it helps to identify trends such as a gradual increase in the average debtor turnover. For example, should the analysis indicate that the average debtor turnover has progressed from 28 days to 36 days over the span of three quarters, this indicates a need to identify the reasons for the increase. The reasons could be internal issues with lag time between preparation and actual mailing of the invoices, or possibly some customers who are taking longer to pay than in the past. Identifying the underlying reasons for the change in turnover make it easier to take appropriate action to protect the cash flow.
