In: Finance
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.
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.