Question

What are the two most common receivables ratios, and what do these ratios tell a stakeholder about the company?

a) Receivables Turnover and Days Sales Outstanding; they indicate how quickly a company collects payments.
b) Quick Ratio and Current Ratio; they measure a company's liquidity.
c) Net Profit Margin and Gross Profit Margin; they assess profitability.
d) Return on Assets and Return on Equity; they evaluate overall financial performance.

Answer 1

The two most common receivables ratios are Receivables Turnover and Days Sales Outstanding (DSO), which provide insights into a company's efficiency in collecting payments and managing cash flow.

Step-by-step explanation:

The two most common receivables ratios are the Receivables Turnover and Days Sales Outstanding (DSO). These ratios are critical metrics that help stakeholders understand how efficiently a company is managing its accounts receivable. The Receivables Turnover ratio indicates how often the company collects its average accounts receivable and is calculated by dividing total net credit sales by the average accounts receivable during a period. A higher turnover ratio suggests that the company is collecting payments faster.

The Days Sales Outstanding, on the other hand, measures the average number of days it takes for a company to collect payment after a sale has been made. It is calculated by dividing the average accounts receivable by the total net credit sales and multiplying the result by the number of days in the period. A lower DSO is preferable as it indicates that the company is able to quickly convert its receivables into cash.

Together, these ratios offer insights into the company's cash flow management and credit policies. Stakeholders can use them to assess how well the company controls credit extended to customers and how quickly it can turn sales into cash, which is crucial for meeting its short-term financial obligations.