interpretation of turnover ratios

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Permalink Reply by Dipu James on May 6, 2009 at 12:38pm

i couldnt get your question can please let us know the formula used;-)

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Permalink Reply by pradeep gupta on May 8, 2009 at 8:02am

what you are talking about is debtor turnover ratio and i will explain you the meaning of ONLY debtor turnover ratio though there more turnover ratios but since your answer is about debtor turnover i will restrict myself to it

debtor turnover ratio formaula is credit sales/average detors(opening debtor+ closing debor/2) this will give you some number assume it as 12 - which means you turnover debtors 12 times in a year (HERE TURNOVER MEANS CONVERTING CREDIT SALES INTO DEBTORS AND THEN EVENTUALLY COLLECTING MONEY FROM DEBTORS, hence you do this process 12 times in a year)

remember this number 12 is only indicating how many times in a year you turnover debtor. now to see how many days it takes to collect credit sales from customer your divide this number 365/12 which gives you 30 days. which effectively means to turnover debtor 1 times you take 30 days. which means to complete one cycle you take 30 days, likewise every additional cycle you take 30 days to collect receivables

am clear, please react

thanks
pradeep

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Permalink Reply by Werner Reisacher on May 8, 2009 at 10:25am

In general, you are correct. But please keep in mind that the 30days represents the avarage # of sales outstanding for all you customers. In order to obtain a more accurate figurre, companies are using the average Accounts receivable balances at the end of the last 3 or 4 months to avoid distortions caused by seasonal sales trends. In such cases, the resulting # of days need to be prorated to the legth of the period selected.
The average result gives you an overall picture only. For more details about the age of the individual receivable balances, you need to establish an Ageing list of receivables. Agein list sort all receivable balances by their # of days outstanding. (Usally in 30 days brackets) This list will flag is your "over 90 days" customer outstanding are growing. Studies have shown, that the probability to collect funds from receivables decreases in a accelerated line compared to the # of days outstanding.
Werner Reisacher

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Permalink Reply by Dyuti on May 11, 2009 at 5:55am

This day's sales outstanding shows the average number of days after which the company is exoected to get back cash from the debtors. This is not equivalent to credit period that is given to the debtors at the time of credit sales. The ratio just shows the average collection period.

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Permalink Reply by Bonolo Paul Nare on May 13, 2009 at 5:06pm

This definately sounds like a debtors collection period calculation. This basically indicates the extent in days, to which average debtors are collected in relation to total credit sales. It is normally calculated in number of days, although percentages can also be used.

You could compare this to lots of information, such as your entity's debtors' age analysis, collection periods of similar companies offering similar terms and conditions, etc. The lower the number of days the better your situation is.

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Permalink Reply by Ramesh S. Mahalingam on May 16, 2009 at 12:59am

To follow on from Werner's point, in real life I've found it very useful to compute DSO (Days' Sales Outstanding) in the following manner for my company: Take the Trade Debtors' balance at year-end, and deduct the December sales. If the remainder is a positive figure, then deduct November sales from the remainder. If the new remainder is positive, then deduct October sales. If the result is negative, then compute what proposrtion of October sales will bring the result to zero (let's say half of Oct sales gets the result to zero). Your DSO is 31+30+15=76 days (that's 31 days for Dec plus 30 days for Nov plus 15 days for half of October). This method eliminates the ills of averaging caused by uneven sales volumes across months. Obviously, if you don't have monthly sales data you can't use this method. Hope this helps!

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Permalink Reply by Sachidanand (Sacha) Singh on May 16, 2009 at 4:28am

Ramesh,

Very interesting approach, thank you for sharing it. But I feel it will ignore the sales other periods (other than sales of Aug, Sep and part of Oct)? That means we trade away ills of averaging for taking the numbers of one period as the representative for the year. Am I right? Perhaps I have not followed the implications of your method correctly. Pl do explain.
Thanks again.

Sacha

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Permalink Reply by Ramesh S. Mahalingam on May 16, 2009 at 3:09pm

Sacha,
Thank you for bringing up an important point I had omitted to mention in my previous post. In my example, the amount sitting in the year-end Receivables is the last 76 days' sales. There is an underlying assumption that sales and collections follow a FIFO method. Under this assumption, therefore, the sales prior to mid-October are irrelevant. Hope this clarifies.
Ramesh

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