Question

In: Finance

High Inc. has an accounts receivable turnover ratio of 7.3. Low Company has an accounts receivable...

High Inc. has an accounts receivable turnover ratio of 7.3. Low Company has an accounts receivable turnover ratio of 5. Assuming that High and Low have the same sales​ level, which of the following statements is​ correct?

A.

Low Company has​ (on average) a lower accounts receivable balance than does High.

B.

​Low's average collection period is less than​ High's.

C.

​High's average collection period is less than​ Low's.

D.

High has a higher accounts receivable balance on average than does Low Company.

Solutions

Expert Solution

Option (C) is correct

First we will check the accounts receivable turnover ratio of both companies as below:

Accounts receivable turnover ratio is given by:

Accounts receivable turnover ratio = Sales / Average accounts receivable

Suppose sales for both the company's is $100.

For High inc:

7.3 = $100 / Average accounts receivable

Average accounts receivable = $100 / 7.3 = 14.

For Low company:

5 = $100 / Average accounts receivable

Average accounts receivable = $100 / 5 = 20.

So, Low company's average accounts receivable is more than High Inc's.

We will now check the average collection period for both the companies as below:

Formula for Average collection period = 365 / Accounts receivable turnover ratio

For High Inc.:

Average collection period = 365 / 7.3 = 50 days

For Low Company:

Average collection period = 365 / 5 = 73 days

So, we can see that High company's average collection period is less than Low's. So option (C) is the answer.


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