How do you calculate asset turnover
How do I calculate average accounts receivable?
The average accounts receivable figure is needed in certain situations to avoid measurement problems. A business typically includes its ending accounts receivable balance in various reports, but there are situations in which this yields incorrect results.
The problems with using the ending accounts receivable balance include:
- The last day of the month tends to be the day with the highest accounts receivable balance.
- The accounts receivable balance may vary massively by month, since sales may be seasonal.
- If you are reporting accounts receivable only on an annual basis, then the only date used will be the year-end figure; since many companies structure their fiscal years to correspond with their lowest business levels, this means that the year-end accounts receivable balance may be well toward the low end of what a company actually experiences over the course of a year.
- A single account receivable amount on a specific day may be inordinately high or low, just because a single large invoice may have been paid too early or too late.
Given these issues, it makes sense to instead calculate an average accounts receivable balance.
When you calculate an average accounts receivable balance, it is easiest to use the month-end balance for each month measured, simply because this information is always recorded in the balance sheet, and so is always available in the accounting records. As just noted, this means that the average amount may be somewhat high. Still, it is the most accessible information, especially if you
are compiling information from previous months or years where the receivable balance for other dates of the month simply is not available.
If you have a strongly seasonal business, the best method for calculating average accounts receivable is to average the ending accounts receivable balance for every month of the last 12 months, thereby incorporating the complete effects of seasonality into the calculation. Please note that this is a trailing 12 months calculation, so you will usually be including the receivable balance from at least a few months in the preceding fiscal year.
If you have a rapidly growing business, then using the average receivable balance for the last 12 months will understate the amount of receivables to be expected on a go-forward basis. Conversely, the average receivable reported for a declining business would be overstated. In these cases, it would be more accurate to average the accounts receivable over just three months.
When should you use the average accounts receivable calculation? Lenders may want to know, so that they can estimate an average possible funding requirement. It may also be useful for the general estimation of budgeted working capital levels. However, you should not use it when conducting cash flow planning, since day-to-day variations in the actual receivable level may be very different from the long-term average. Also, always show a prospective lender your estimated accounts receivable level in every period over which lending may occur, so the lender can determine the most appropriate maximum funding level - presenting an average balance is not helpful in this situation.
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