The accounts receivable turnover is calculated by:
A. Dividing net sales by average accounts receivable.
B. Dividing net sales by average accounts receivable and multiplying by 365.
C. Dividing average accounts receivable by net sales.
D. Dividing average accounts receivable by net sales and multiplying by 365.
E. Dividing net income by average accounts receivable.
The correct answer and explanation is :
The correct answer is:
A. Dividing net sales by average accounts receivable.
Explanation:
The accounts receivable turnover ratio is a financial metric that measures how effectively a company manages its receivables and how quickly it can collect the outstanding accounts. The formula for calculating this ratio is:
Accounts Receivable Turnover = Net Sales / Average Accounts Receivable
Here’s a breakdown of each component:
- Net Sales: This is the total revenue from goods sold or services provided, after accounting for any returns, allowances, or discounts.
- Average Accounts Receivable: This is calculated by taking the beginning and ending accounts receivable balances for the period and dividing by two. This gives the average amount of money the company is owed by customers during that period.
The ratio gives insight into the efficiency of a company in collecting its receivables. A higher ratio indicates that a company is able to collect its accounts receivable more quickly, which is generally seen as a positive sign of operational efficiency and liquidity. On the other hand, a lower ratio may suggest that the company has trouble collecting its receivables, which could lead to cash flow problems or indicate issues with its credit policies or customer payment behaviors.
While the formula in option B, “dividing net sales by average accounts receivable and multiplying by 365,” also calculates a useful metric, which is the accounts receivable days (the average number of days it takes to collect receivables), the correct formula for the turnover ratio, specifically, is just the division of net sales by average accounts receivable. The days formula is helpful for understanding the time it typically takes to collect those receivables.
Therefore, the correct answer is A, and the concept is fundamental for assessing the company’s working capital and overall financial health.