Weighted Average Collection Example:

CFA Level I
#1

Weighted average collection on recievebles increased from 50 to 55 days.

Average days recieveables decreased from 52 to 48 days.

What is the most likely scenario?

  1. Credit standard were relaxed

  2. Credit customers are paying more slowly this year

  3. credit sales are a greater part of the firm this year.

The answer is 2. But I do get why it could not be number 1 or 3.

Basically, what is the difference between weighted average collection and the average days recieveables in terms of credit policy for a company?

#2

Here is an answer that was posted before for an almost identical problem:

PROBLEM:

Schweser study notes Book 4, Assigned Reading 46, concept checkers, page 65, question 5:

b corp has found that its weighted average collection period has increased from 45 days last year to 55 days this year, and its average days of receivables this year is 13 compared to 22 last year. it is most likely that: a. b has relaxed its credit standards this year. b. fewer of its customers are taking advantage of discounts for early payment. c. b’s credit customers are paying more slowly this year. d. credit sales are a greater part of their business this year.

this question is confusing me. shouldn’t these two metrics always be moving in parallel? how can your average collection period increase but your days receivable go down? under what scenario would this be the case?

ANSWER

CND,

This one really threw me a curve but I think I’ve got it now.

Answer is C

Not A because you would probably see an increase in Avg Days Receivables with relaxed credit standards. Not D because Avg Days of Receivables would increase if credit sales were a greater part of sales (similar to A)

So you’re left with B or C

I don’t think you could comment one way or another on B

So C because an increasing WA Collection period would be consistent with customers paying more slowly.

Average Days of Receivables is a measure of how many receivables you have.

Weighted Average Collection Period is a measure of how long your receivables have been outstanding.

The amount of receivables you have and the length of time they’ve been outstanding are not related so Avg Days Receivables and WA Collection Period can be different.

Say you have a smaller amount of receivables in 2008 than you did in 2007 but the receivables you do have in 2008 have been outstanding for longer than than the receivables you had in 2007. If you have constant revenues, Avg days receivables will decrease while WA Collection period will increase. Remember the receivables you have in 2008 are not likely the same receivables you had in 2007.

Hope that helps, MDD

#3

Yes that helped. Thanks!

#4

One question, how come the avg. accounts recieveables would increase if credit sales were a bigger component of the business?

#5

Average of days receivable or DSO has decreased from 22 to 13 this year, so it’s taking the company less time to collect its accounts receivables.

If the average days of receivables or DSO increases (which is not the case in the excercise statement)it shows the company is selling on credit so D doesn’t make sense.

To sum up, D would make sense if DSO/average days receivables would have increased not decreased.

If still not clear: http://www.investopedia.com/terms/d/dso.asp

That’s how I understand it, I hope I am not wrong.

Good luck