Jon Bone explains receivables turnover as “How many times we collect the cash from customers per year”
???
formula is : Annual Sales/Average Receivables
So if for the year I had sales of $300,000 and Average Receivables of $50,000 it means I collect cash 6 times per year? What? I totally don’t understand the logic here. What if 1 person bought $50,000 from me and paid on credit on January 1st and they don’t pay me until 12/31and everyone else paid cash for the $250,000 remainder. How does the idea that I collected cash 6 times make any sense? $50,000 of receivables would have been on the balance sheet all year.
Or is he trying to say that we collect cash of 6 times the receivables amount?
To further this, Days of Sales outstanding is 365/Receivables turnover, and he explains that it’s how many days on average it takes customers to pay.
Again, same thing, if the Receivables Turnover was 6 in the situation I described above, then the DSO would be 365/6 = 60.833 days on average for customers to pay.
I guess I could accept that much easier because 16.67% of my business took 365 days to pay that mathematically drags the average down.
Would this just be something that would be mentioned in the Notes as a major customer or something to make analysts aware of the skewing of the Receivables?
For me, receivable turnover is the amount of times the business receives all the money that constitutes receivables on the balance sheet. What he might have omitted is that it is the ‘theoritical’’ amount and not the amount that the company receives in reality. The reason fot his is because no company will reveive all the money from clients within one year. But in theory, it is it is the actual number of times the company ‘depletes’ (receive money) its receivables. Look in the CFA curriculum, they probably explain it better than Bone and I for that matter lol.
While you are right, you are over thinking this problem for the Level 1 CFA. Level 2 CFA you will deal with the quality of the accruals (the likelihood the account receivables will be paid back and the ratio of this accrual to cash),
In Level 1 it’s a bit simpler, if all of your customers were good and paid back the account receivables within a short time period (within your fiscal year), how many days does it take to turn your cash into a product you create (or buy from a wholesaler) and you sell in return for an account receivable which will later be turned back into cash when you receive cash for your customers.
Let’s use your example again, say you are looking at a furniture store who lets customers (if they want, they are not obligated) to pay no money down on furniture. You would record the sale of the furniture and an account receivable for the same price. However not all the customers want to wait to pay the furniture, some prefer to pay cash now. Receivables Turnover (in its simplest terms) state that if you have $300k in sales and $50k in account receivables a ratio of 6 means for every $6 of sales there was $1 of account receivables.
You want the ratio to be at least greater than one. This means the company received more cash for the furniture sale than they gave in “store credit” to people who preferred not to pay for the furniture now.
As an anlyst, if you were comparing similar companies, all else being equal, you would favor the company with the higher receivable turnover of 6 to a company with say a receivable turnover of 2 (which means for every $2 of sales, $1 was an account receivable - meaning the company has only seen half the money they have spent on buying furniture to sell to customers), As an analyst you would recommend buying the company with the receivable turnover of 6 and not recommend buying the company with a receivable turnover of only 2.
DSO takes a while to explain. But I hope I have answered your first question.