- July 29, 2020
- Posted by: saenicsa
- Category: Consulting
A financial ratio is a manner of expressing a relationship between 2 components of your financial statements in a more meaningful way that gives a better idea of the financial standing of a company.
Today we will discuss a very simple but important ratio we all should be aware of, especially taxpayers that invoice annually more than C$ 12 million Córdobas a year and make a considerable amount of their sales on credit. The ratio we are referring to is referred to as the Receivables Turnover Ratio.
Look towards your Balance Sheet
For your Receivables Turnover Ratio, we will first need to take a look at the all-important Balance Sheet. This is because on the income statement, we only see revenues but on the Balance Sheet we see the invoices that we have billed to our customers/clients and that are pending payment.
Learn more about the Balance Sheet: What is the Balance Sheet?
Where exactly de we need to look? Well you will want to look at the left-hand side of your Balance Sheet where the Assets are shown.
Under Current Assets, what you should she most likely will be similar to this:
The item we are looking for here is Accounts Receivables.
What are Accounts Receivables?
A company in Nicaragua that has gross sales of C$ 12 million Cordobas or more per annum, uses a different accounting method than those that do not, we are referring to the Accrual method.
If your business grosses less than C$12 million Cordobas, then the system that you use is a Cash Basis accounting.
What is the difference between the two? The difference between a Cash Basis and Accrual method is that the timing for accounting for income and expenses for a company is based on an immediate recognition of what goes in and goes out, while the latter permits recording not just the inflow and outflow of income and expenses, but also the anticipation of either.
Many times, these types of companies have to anticipate the fees (income) they are to receive when they bill clients, so a lot of times you will see on the Balance Sheet an entry for Receivables under the Assets section.
On the other hand, if your company grosses less than C$ 12 million Cordobas but uses credit for a lot of its sales then you too most likely should have a section under Assets for Receivables.
Receivables Turnover Ratio
On the onset of this article we mentioned what a financial ration was, in this case we had mentioned that a financial ratio is a manner of expressing a relationship between 2 components of your financial statements in a more meaningful way.
Therefore, when discussing the Receivables Turnover Ratio, we are trying to express in a more meaning full way a relation that exists within this specific account on your Balance Sheet.
What do we mean? We mean that just because there is a balance in the Receivables account that doesn’t always mean good news, in fact it could be a warning sign and the receivables turnover ratio helps us identify just that. Let me explain…
If you were to give no further consideration to the fluctuations of the balance from month to month of the Receivables account then you may inadvertently be overlooking that your company is not doing a good job of collecting payments from clients and additionally if that account continues to grow without being checked it may even be a sign that your current credit policy is defunct and very soon more than likely you will run out of cash, in other words go bankrupt.
Bottom Line: Receivables Turnover Ratio
So what do you want to do? Well it is important to take note of the Receivables section on your Balance Sheet, do not think of it as money in the bank.
Instead keep track of it and do the following ratio to have a better understanding of its nature:
Now this is the basic formula to follow, but it is important to know what information goes where and more importantly where to find that information.
That will be a topic for another article, but we hope that today we have sparked your interest in this topic.
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