4. Gilad Zuar, an analyst, observed an increase in a company’s receivables turnover.
Which of the following could explain this trend?
a. The company increased the allowance for doubtful accounts this year.
b. The company adopted more lenient credit terms for its customers
c. Due to a general economic downturn, customers needed to delay payments to
the company
d. The company agreed on more lenient credit terms with its suppliers.
Salman is right, option A is the correct answer.
I will say A is the correct answer…
Let’s see how.
Suppose Sales is 100,000/= and Average Receivables are 10,000/=
Turnover will be 100,000/10,000 = 10
a) Increased the allowance for doubtful debt.
Accounting treatment is to deduct allowance from the value of the receivables. This will bring down the average receivables. New average receivable will become say $ 9,000/=
Calculations:
Turnover = 100,000/9,000 = 11.1
b) Lenient credit terms.
These will result in higher average receivables because the company is now allowing its customers to pay at a later date. New average receivable will become say $ 11,000/=
Calculations:
Turnover = 100,000/11,000 = 9.09
c) Delayed Payments
Have the same impact as B because of the piling up of receivables.
d) Lenient credit terms from its suppliers.
This will have no impact on the inventory turnover because they are related to purchases and suppliers.
I hope it helps.
You might be mixing two things together. The turnover ratio represents the effeciency. The ratio you are talking about is measured using the number of days of sales outstanding. The days of sales outstanding is different from the receivable turnover ratio.
You are right Salman, thanks for the clarity.
That is because AR writing-off (increasing AR deduction by forming the allowance for doubtful accounts) has same effect on AR turnover ratio as collecting receivables. So, unrelated to this question, for efficient FR analysis is advisable to test various indicators through multiple time periods.
When studying, it is always good to review why the other answers are wrong.
For example…
B) increasing credit term for customers will increase receivables, so definitely DECREASE turnover
C) Same as above, increase in receivables will decrease receivable turnover
D) This has nothing to do with receivables, paying your suppliers affect payables.
Candidates must fully understand all the concepts in a question, because they can change the question slightly and you want to make sure you can comprehend the questions regardless how they word them!
That’s my advice!
NANA
How will an increase in lenient credit terms lead to an increase in receivables, i thought that will lead to an increase in days of receivable (No of day sales outstanding).
Please explain.
Lenient conditions lending includes longer terms of receivables payment by customers.
BS records express positions snapshot on a particular day (eg. 31/12) thus BS positions are static indications. Account receivables is a balance sheet position on that particular day. If customers have lenient PO conditions, it actually means that the position of account receivable tend to a higher balance on a given day. In contrast, position “Sales” is a P/L item (Income Statement), therefore revenue. P / L measures a company’s financial performance over a specific accounting period. Since P/L items do not express only certain date position (as BS items) than are referred to period as a whole (e.g. fiscal year or quarter), item “sales” is already shown on average basis in P/L. This is also the reason why when calculating receivables turnover ratio, position AR should also be displayed at an average basis (to avoid biased estimator). DSO is an indicator derived from the receivables turnover ratio, what means that the factors with impact on receivables turnover ratio (like the lenient credit terms) have same impact on DSO.
No problem! Glad to help you!
and Thank you.