Question

The receivables turnover ratio provides a way for an analyst to assess the effectiveness of a company in managing its investment in receivables. True or False?

Answer 1

The receivables turnover ratio accurately assesses a company's efficiency in managing its receivables, with a higher ratio indicating more frequent collection.

Step-by-step explanation:

The statement is true: the receivables turnover ratio is indeed a financial metric used by analysts to evaluate how efficiently a company manages its investment in receivables. The ratio is calculated by dividing the net credit sales of a company by its average accounts receivables. A higher ratio indicates that the company is collecting on its receivables more frequently throughout the year. This is a critical piece of analysis as it helps indicate how well a company is handling its credit policies and cash collection processes, which are both key to maintaining healthy cash flows.

Answer 2

The given statement "The receivables turnover ratio provides a way for an analyst to assess the effectiveness of a company in managing its investment in receivables" is True.

Step-by-step explanation:

The receivables turnover ratio indeed offers insight into a company's efficiency in managing its receivables. Calculated by dividing net credit sales by average accounts receivable, it measures how many times during a period a company collects its average accounts receivable balance. A higher ratio generally indicates more effective management of receivables, showcasing the company's ability to convert credit sales into cash quickly. For instance, if a company has a ratio of 8, it implies that, on average, the company collects its outstanding receivables 8 times within the considered period.

The formula for receivables turnover ratio is:

Receivables Turnover Ratio = Net Credit Sales / Average Accounts Receivable

This ratio aids analysts in understanding the efficiency of a company's credit policies and how well it manages its outstanding receivables. Higher turnovers are favorable, signaling prompt collections and a reduced risk of bad debts. Conversely, a lower turnover may suggest issues with collections or a lenient credit policy, potentially leading to cash flow problems or increased bad debts. By comparing this ratio with industry benchmarks or historical data, analysts can gauge the company's performance in managing its receivables efficiently. Therefore, the receivables turnover ratio serves as a valuable metric for assessing a company's effectiveness in handling its investments in receivables.