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Chapter 8: Problem 5

A business has an accounts receivable turnover of ten. What is the company's average collection period? a. \(36.0\) b. \(30.8\) c. \(34.6\) d. \(36.5\)

Short Answer

Expert verified
The average collection period is 36.5 days, so option d is correct.

Step by step solution

01

Understand the Formula

The accounts receivable turnover ratio is a measure of how quickly a company collects cash from its credit sales. The average collection period can be calculated using the formula: \[\text{Average Collection Period} = \frac{365}{\text{Accounts Receivable Turnover}}\] This formula assumes a 365-day year and tells us the average number of days it takes for a company to receive payments from its customers.
02

Substitute the Given Values

We are given that the accounts receivable turnover is 10. Substituting this value into the formula gives us: \[\text{Average Collection Period} = \frac{365}{10}\]
03

Perform the Calculation

Divide 365 by 10 to find the average collection period: \[\text{Average Collection Period} = 36.5\] This calculation gives us the average number of days it takes for a company to collect its receivables.
04

Identify the Correct Answer

Look at the given options: \(a.\ 36.0\), \(b.\ 30.8\), \(c.\ 34.6\), \(d.\ 36.5\). From our calculation, the average collection period is 36.5 days. Thus, the correct answer is option \(d\).

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Average Collection Period
The average collection period is an important metric that indicates the average number of days it takes a company to collect payments for its credit sales. This is calculated using the formula \( \text{Average Collection Period} = \frac{365}{\text{Accounts Receivable Turnover}} \). It provides insight into how efficiently a company manages its receivables.

A lower average collection period implies quicker collection from customers, improving liquidity and reducing the risk of bad debts. Conversely, a higher period could indicate issues in collecting payments, affecting cash flow.
  • A shorter collection period is desirable as it means quicker cash inflow.
  • Comparing it to industry norms helps gauge performance.
  • It is crucial for maintaining a healthy cash flow cycle.
Credit Sales
Credit sales refer to sales made by a company where the payment is deferred to a later date. These are common in business-to-business (B2B) transactions where immediate payment isn't always feasible. Managing credit sales efficiently is essential to ensure sufficient cash flow.

When offering credit sales, businesses need to carefully weigh the benefits against the risks. While they can boost sales volumes and foster customer loyalty, they also increase the risk of bad debts and impact liquidity if not managed properly.
  • Credit policies can be customized to balance sales growth and risk management.
  • Clear terms and conditions can enhance customer understanding and compliance.
  • Regular monitoring of accounts helps in timely collections.
Financial Ratios
Financial ratios are valuable tools that help in assessing a company's financial health. They provide insights into various aspects of business performance like profitability, liquidity, and solvency. Among these, efficiency ratios like accounts receivable turnover are crucial for evaluating how well a company manages its receivables collection process.

Different types of financial ratios serve different purposes:
  • Liquidity ratios assess the ability to meet short-term obligations.
  • Profitability ratios evaluate earnings relative to revenue, assets, or equity.
  • Efficiency ratios measure how effectively a company uses its resources.
Using these ratios, stakeholders can compare past performance, industry benchmarks, and peers to better understand a company's financial positioning.
Accounts Receivable Management
Accounts receivable management is the practice of ensuring that customers pay their invoices on time. It involves monitoring and collecting outstanding balances, managing credit risk, and optimizing the cash flow cycle.

Effective receivables management includes:
  • Establishing clear credit policies and terms.
  • Vetting customers' creditworthiness before extending credit.
  • Implementing robust invoicing and follow-up processes.
  • Using software solutions for tracking and managing collections.
Proper management of accounts receivable ensures steady cash flow, reduces the likelihood of bad debts, and improves overall financial health.

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Most popular questions from this chapter

Credit Card Sales Lake Heart Marina sells boats and other water recreational vehicles (approximately three vehicles are sold each week). The following transactions occurred during the third week of May: May 15 Sold a \(\$ 1,500\) boat trailer \((\$ 760\) cost \()\) to Ed and Jane Peeler, who paid using a personal check. 16 Sold a \(\$ 20,000\) boat ( \(\$ 13,000\) cost) to the Lake Heart Lake Patrol on account, with \(2 / 10\), n/30 terms. 18 Sold a \(\$ 2,800\) water scooter ( \(\$ 1,500\) cost) to Bryan Wagner, who used the United Merchants Card to charge the cost of the water scooter. Lake Heart Marina mailed the credit card sales slip to United Merchants the same day. United Merchants will send a check within seven days, net of a three percent fee. 19 Sold a \(\$ 9,000\) fishing boat \((\$ 5,000\) cost) to Michael Moffett, who used the Great American Bank Card to pay for the boat. Lake Heart Marina deposited the credit card sales slip the same day and received an immediate credit in the company's checking account, net of a two percent fee. 20 Received payment from the Lake Heart Lake Patrol for the boat purchased on May \(16 .\) 21 Received payment from United Merchants for the May 18 transaction. Required Prepare journal entries to record these transactions. The Lake Heart Marina uses a perpetual inventory system.

When a previously written-off account receivable is collected, it must first be reinstated by debiting the Accounts Receivable account and crediting the Allowance for Doubtful Accounts. Explain the credit portion of the reinstatement journal entry.

Journal Entries for Accounts and Notes Receivable Austin, Inc., began business on January \(1 .\) Several transactions for the year follow: May 2 Received a \(\$ 30,000,60\) day, ten percent note on account from the Haskins Company. July 1 Received payment from Haskins for its note plus interest. 1 Received a \(\$ 61,000,120\) day, nine percent note from \(\mathrm{R}\). Longo Company on account. Oct. 29 R. Longo failed to pay its note. Dec. 9 Wrote off R. Longo's account as uncollectible. Austin, Inc., uses the allowance method of providing for credit losses. 11 Received a \(\$ 42,000,90\) day, 12 percent note from R. Canal on account. 31 Recorded expected credit losses for the year by an adjusting entry. Accounts written off during this first year have created a debit balance in the Allowance for Doubtful Accounts of \(\$ 61,000\). An analysis of aged accounts receivables indicates that the desired balance of the allowance account should be \(\$ 13,200\). 31 Made the appropriate adjusting entries for interest. Required Record the foregoing transactions and adjustments in general journal form.

Direct Write-Off Method The direct write-off method is not generally accepted because: a. The method overstates the bad debts expense. b. It is too complex. c. The method fails to match sales revenue with expenses in the appropriate time period. d. The method causes liabilities to be overstated.

Calculating Interest on Promissory Notes Receivable Houston Company receives a six-month note from a customer. The note has a face amount of \(\$ 8,000\) and an interest rate of nine percent. What is the total amount of interest income to be received? a. \(\$ 720\) b. \(\$ 540\) c. \(\$ 360\) d. \(\$ 180\)
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