Days in Accounts Receivable Ratio

Cash flow is the most important short term factor in business survival. The days in accounts receivable ratio is a key barometer of the funding situation of a company.

 

A company that provides customers credit, or that allows payments over time needs to have a good understanding of when they can be expect to be paid.  Looking at historical ratios can provide insight, as well as offering an opportunity against other companies.

 

The days in accounts receivable ratio is, as the name implies, is the calculation of how many days of cash are locked up in receivables.  Receivables are the money is that is owed the company.

 

Calculating Days in Accounts Receivable (A/R)

 

There are two factors involved in the calculation:

The accounts receivable at a point in time.

The revenue generated by the company over a specific period.

 

An example with the following variables:

Revenue over the first three months of the year equals $90,000.

Accounts receivable on the books at 3/31 equals $30,000.

 

Days in A/R are calculated by dividing revenue by the number of days in the period to get the average daily revenue and then dividing that number into the accounts receivable.

 

Average daily revenue ($90,000 divided by 90 days) = $1,000 per day

A/R ($60,000) divided by average daily revenue ($1,000) = 60 days in accounts receivable.

 

The Importance of Days in Accounts Receivable

 

What this calculation is saying is that on average it will take 60 days to collect what it is owed.  If the company pays its bills today, it will take 60 days to replace that money.   The company must have a reserve of $60,000 in order to remain solvent.

 

The ratio is best used as an indicator to compare time periods or against like companies.  If the number is increasing from a prior year, it may indicate a problem.  The company can positively impact the ratio by becoming more aggressive in collecting debts. 

 

Since industries differ in customers and payment terms, it may not helpful measure against non-similar companies.  Comparing against a competitor or an industry benchmark can inform the company on the success of its credit and collection efforts.

 

Limitations of the Days in A/R Calculation

 

This calculation is only valid if the company has a solid history of generating revenue and collecting bills.   A new company is likely to have a lower ratio, but keeping the ratio at 60 days (for instance) means that as new revenue is generated, the older accounts have to be collected.

 

Many companies use the 90 days measurement of revenue, but other time periods may be more appropriate.  Too short a time frame may give inconsistent and less useful results, and too long may be useful in spotting trends. 

 

Days in Accounts Receivable is an important business ratio, but to get the full picture of a company, it should be combined with other measurements, including return on investment and net income.

 

Choosing a Career in Accounting

Accounting is a growing field with lots of opportunities, but the lifestyle is not for everyone.  Having a steady job is good, but there are trade-offs to making money.

 

When making a career choice, many young people with an affinity for numbers make a decision to enter accounting.  Business schools have bachelor programs for accountants, and there are openings in businesses, government and auditing firms.

 

Questionable business practices and the resulting government regulation have increased positions for accountants.  A Certified Public Accountant with expertise in Sarbanes-Oxley compliance is very valuable. 

 

The long hours, hard work and pressure situations make the accounting field inappropriate for everyone.  Even those with great mathematical skills may be ill-suited to the rigor and monotony of the life of accountant.

 

Positives of an Accounting Career

 

The primary reason many end up in accounting is that it is a specific career.  Courses taken in college provide specific training. Many students can walk out of college and apply the lessons immediately at a job.  

 

In contrast, a major in mathematics or economics does not train the student for a particular occupation.   There is more flexibility, but less security.

 

Accounting is an indoor job, not a lot of heavy lifting, other than briefcases.  Today, computers play a large role, and accountants need to be able to use spreadsheets and word processing software.

 

As a white collar occupation, the pay is good, with starting salaries above $50,000 in some markets.  Mobility is fairly easy, within a country.  Crossing borders is more difficult since rules vary by country. 

 

Accounting is not bookkeeping.  There is considerable challenge in identifying issues and solving mathematic problems.  There is often interaction with others, which may include clients, peers or subordinates.

 

There are many opportunities for advancement, to the highest financial position in the organization; partner, chief financial officer or treasurer, depending on the type of company. 

 

Negatives of an Accounting Career

 

Accounting is a rigorous profession.  Most accountants, especially at the beginning of their career, are expected to work long hours and weekends. 

 

Staff at auditing firms, particularly, work many hours in their first years, doing basic accounting reviews on the road, in firms that tolerate their presence at best. 

 

The expression used at these firms “three years, up or out” embodies the experience.  Staff either get used to the hours, or move to other companies or professions. 

 

The work can be tedious and become monotonous.  In a business, there is a regular month end closing process, and no vacations can be taken during this time, and weekends are expected.

 

There is a stigma of the bean counter, evidenced by people in other professions.  The role itself is a matter of monitoring and reporting on others, rather than creating business.  It is not a good fit for an entrepreneurial person, or someone needing a lot of human interaction.  

 

With the long hours and indoor work accomplished mostly by sitting, it is not a healthy occupation. 

 

Finding the Right Career

 

A student should carefully assess their strengths and desires before deciding on a career.  Accounting offers stability and financial rewards, but requires mathematical ability and a strong work ethic.