Question

Which of the following statements is CORRECT?

a. If a security analyst saw that a firm's days' sales outstanding (DSO) was higher than the industry average, and was increasing and trending still higher, this would be interpreted as a sign of strength.
b. A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to evaluate the firm's DSO with the firm's credit terms.
c. There is no relationship between the days' sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.
d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.
e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding will decline.

Answer 1

The correct answer is e, which states that if a firm increases sales while keeping accounts receivable constant, its days' sales outstanding (DSO) will fall, indicating more efficient collections. The other statements contain inaccuracies regarding the implications of high DSO, the relationship between DSO and ACP, and the effects on liquidity ratios.

Step-by-step explanation:

The correct statement among the options provided is e. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days' sales outstanding (DSO) will decline. The days' sales outstanding is a measure of the average number of days that a company takes to collect revenue after a sale has been made. A lower DSO value means that the company is able to collect its receivables more quickly.

The other statements provided have inaccuracies:
a. A higher than average DSO that is increasing would indicate potential problems with credit policies or customer payment habits, not a sign of strength.
b. A high DSO does not necessarily indicate that none of the customers are paying on time, but it may reflect longer credit terms or slower collection processes, and it is important to evaluate a firm's DSO in relation to its credit terms.
c. DSO and average collection period (ACP) are related; both measure the average time sales remain as receivables before they are collected.
d. A reduction in accounts receivable would usually increase the current ratio as well as the quick ratio, since it would indicate that the company has more liquid assets in relation to its short-term liabilities.