The account receivable turnover measures:
A. How long it takes to sell accounts receivable to a factor.
B. How often, on average, receivables are received and collected during the period.
C. The relation of cash sales to credit sales.
D. How long it takes to sell merchandise inventory.
E. All of the options are correct.
The correct answer and explanation is :
The correct answer is:
B. How often, on average, receivables are received and collected during the period.
Explanation:
The accounts receivable turnover ratio is a financial metric used to measure how effectively a company manages and collects its accounts receivable. It indicates how many times, on average, the company collects its outstanding receivables over a specific period (usually a year). This ratio provides insight into the efficiency of a company’s credit policies and its ability to convert credit sales into cash.
The formula for the accounts receivable turnover is:
$$
\text{Accounts Receivable Turnover} = \frac{\text{Net Credit Sales}}{\text{Average Accounts Receivable}}
$$
Where:
- Net Credit Sales refers to the total sales made on credit (excluding returns or allowances).
- Average Accounts Receivable is typically calculated as the average of the beginning and ending accounts receivable balances for the period.
A high turnover ratio generally implies that the company is efficient in collecting its receivables, meaning it quickly converts credit sales into cash. This can be seen as a positive sign of effective credit control and cash flow management. A low turnover ratio, on the other hand, suggests inefficiencies in collecting payments, potentially indicating problems with customer creditworthiness or credit collection policies.
Why the Other Options Are Incorrect:
- A. How long it takes to sell accounts receivable to a factor: This refers to factoring receivables, where a business sells its receivables to a third party (a factor) at a discount, and is not related to the accounts receivable turnover ratio.
- C. The relation of cash sales to credit sales: This focuses on the breakdown of sales types, which is not what the accounts receivable turnover measures.
- D. How long it takes to sell merchandise inventory: This is related to inventory turnover, which measures how quickly inventory is sold, not how quickly receivables are collected.
- E. All of the options are correct: Since only option B is correct, this option is incorrect.
In conclusion, the accounts receivable turnover ratio directly measures how often, on average, receivables are received and collected, making option B the correct answer.