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liquidity. Or, more simply, achieving better turnover of working capital can significantly improve
liquidity. Therefore, turnover ratios provide valuable information. The working capital turnover ratios
are described next.
Accounts Receivable Turnover
For accounts receivable turnover, the calculation is as follows:
So, if credit sales are $120,000 and accounts receivable are $30,000, then:
This shows that, on average, accounts receivable turn over four times a year, or every 91 days.
The 91-day turnover period is found by dividing a year, 365 days, by the accounts receivable
turnover ratio of 4, to get the average of 91 days. This is how long on average it takes to collect
accounts receivable. That is fine if our credit terms call for payment 90 days from invoice. But it is not
fine if credit terms are 60 days, and it is alarming if credit terms are 30 days.
Accounts receivable, unlike vintage wines or antiques, do not improve with age. Accounts
receivable turnover should be in line with credit terms, and it signals increasing danger to liquidity as
turnover gets further out of line with credit terms.
Inventory Turnover
Inventory turnover is computed in the following manner:
If cost of goods sold is $100,000 and inventory is $20,000, then:
This shows that, on average, inventory turns over five times a year, or about every 70 days.
In the case of accounts receivable turnover, the numerator was Credit Sales. But for inventory
turnover, the numerator is Cost of Goods Sold. The reason is that both accounts receivable and sales
are measured in terms of the selling price of the goods involved. That makes the accounts receivable