Company's Financial Accounting
Turnover of the working capital items
Coefficients: Accounts receivable turnover, Accounts payable turnover and Inventory turnover
Indicators: Accounts receivable turnover (in Finnish, myyntisaamisten kiertoaika) and Accounts payable turnover (in Finnish, ostovelkojen kiertoaika)
Accounts receivable turnover is the ratio that determines how quickly the company turn its sales into cash, i.e. how fast or slow it is collecting receivables. In order to calculate we need the data from Balance Sheet and Income Statement Let’s consider hypothetical company X.
The Accounts receivable turnover in days calculates as following:
The result means how many days on average it takes to collect of accounts receivables. The higher this number, the more time it takes to collect receivables and the more slowly the company will get the cash and use it for other needs. Nevertheless, you should interpret the result based on the payment policy for your customers. If your customers have a 30-day payment policy, then the result in 36,5 says that on an average your customers are paying 7 day late. Opposite, if your customers have a 40-day payment policy, then the result in 36,5 says that on an average your customers are paying 3 day earlier and this is a good result.
In the same way it is possible to check, how the company pays its own invoices. Accounts payable turnover shows a company’s ability to pay off its suppliers, it determines how fast the company is managing its obligations.
The Accounts payable turnover in days calculates as following:
Purchases = Raw materials and services costs (data from income statement)
The result indicates how many days on average it takes to pay creditors. The higher this number, the more time it takes to make payments and the more slowly the company will fulfil its obligations. Nevertheless, you should interpret the result based on the payment policy according agreements with your creditors. For example, if your you have a 30-day payment policy, then the result in 51,1 says that you pay very slowly.
Then you can compare two indicators, accounts receivable turnover and accounts payable turnover, in order to understand if you have enough money to pay all your invoices. According to our results, we have:
Accounts receivable turnover (36,5 days) ˂ Accounts payable turnover (51,1 days)This result means, that our company accumulates money faster than the purchase invoices are paid.
In the same way we can calculate Accounts receivable turnover ratio (in Finnish, myyntisaatavien kiertonopeus) and Accounts payable turnover ratio (in Finnish, ostovelkojen kiertonopeus). The interpretation of these metrics is the same as previous: Accounts receivable turnover ratio indicates how quickly the funds from customers are received. Accounts payable turnover ratio indicates how quickly the company pays its suppliers. The calculations of Accounts receivable turnover ratio (Accounts receivable turnover speed) and Accounts payable turnover ratio (Accounts payable turnover speed) are the following:
The result means that we collect our accounts receivable approximately 10 times over the fiscal year.
Accounts receivable turnover in days = 365 days/ 10 = 36,5 daysThe result means that we pay to our suppliers approximately 7,1 times during the fiscal year.
Accounts payable turnover in days = 365 days/ 7,1 = 51,1 days
Indicator: Inventory turnover ratio (in Finnish, vaihto-omaisuuden kiertoaika, varaston kiertoaika)
Inventory turnover ratio describes the average time during which products, semi-finished products, raw materials etc. are in the stock. Other names of this indicator: stock turnover, stock turn or inventory turns. It measures how many times a company replaces its stock of goods during a certain period. In order to calculate this metric, we need the data from Balance Sheet and Income Statement. Let’s consider hypothetical company X.
The Inventory turnover in days calculates as following:
COGS or Cost of goods sold = Beginning inventory + Purchases - Ending inventory
Change in inventories (or Variation in inventories) = Beginning inventory - Ending inventory
The Inventory turnover ratio calculates as following:
The result means that inventory turnover take place 1,5 times a year, i.e. the company sells and replaces its stock of goods approximately 2 times a year.
Stock turnover in days = 365 days / inventory turnover speed =365 days / 1,5 = 243,3 days
In our calculations we have got quite long period of inventory turnover, that can be caused due to poor sales, overstock or bad management.
The high inventory turnover indicates better efficiency, whereas the low one ineffectiveness, but this indicator considerably varies by the industry. For example, the low result of this coefficient is a normal one for luxury goods.