Final answer:
An increasing collection period for accounts receivable suggests that a firm's credit policy may be too lenient, leading to potential cash flow issues and a higher risk of default. It reflects a similar concern lenders have when borrowers have a record of late payments.
Step-by-step explanation:
An increasing collection period for accounts receivable implies that a firm is taking longer to collect payments from its customers. This scenario often suggests that the firm's credit policy may be too lenient, allowing customers more time to pay their debts. Such a policy could potentially lead to a higher risk of default, which can impact a firm's liquidity and financial stability. Just like a lender would find a borrower with a history of late payments less reliable and want to pay less for that loan, a firm with an increasing collection period may find it difficult to manage its cash flows effectively.
Loose credit policies may attract more customers in the short term, but they could lead to issues with cash flow if a significant number of customers delay their payments or default entirely. It's important for a firm to balance the attractiveness of its credit terms with the ability to ensure timely repayment, which is critical for maintaining the firm's financial health.