Hello all, Whats the answer to the Q below? A firm has average days of receivables outstanding of 22 compared to an industry average of 29 days. An analyst would most likely conclude that the firm: A) may have credit policies that are too strict. B) has better credit controls than its peer companies. C) makes less credit sales than the average firm in its industry. D) has a lower cash conversion cycle than its peer companies. Ans : A The firm’s average days of receivables should be close to the industry average. A significantly lower average days receivables outstanding, compared to its peers, is an indication that the firm’s credit policy may be too strict and that sales are being lost to peers because of this. We can not assume that stricter credit controls than the average for the industry are “better.” We cannot conclude that credit sales are less, they may be more, but just made on stricter terms. The average days of receivables are only one component of the cash conversion cycle. I thought : i) small value Avg day receivable = big receivables turnover ii) Big receivables turnover = high sales or low avg. receivables why can’t answer be C? Thaanks in advance for your help!
Say the firm in question makes 100 credit sales (of $1 each) with a term of 2 days each vs the indusry average of 20 credit sales (of $1 each) for 20 days each. The firm in question will have lower days in receivable but clearly makes more credit sales than the inustry average (100 > 20). Therefore C is not necessarily correct.
I agree with you. (edit. the original poster) Less credit sales implies a lower average receivables, which implies a higher receivables turnover which implies a lower days of receivables outstanding. Too strict credit policies likewise will result in lower average receivables. I think it’s a lame question, plus their explanation is silly “We cannot conclude that credit sales are less, they may be more, but just made on stricter terms.” I don’t think we can conclude that their terms are neccesarily stricter anywan, what if they have generous terms but almost zero credit sales? just because you offer generous terms doesn’t have to mean high receivables. The ice cream van man may offer generous terms to purchase a $2 ice cream but I’ll probably just pay him cash anyway.
ah hang, I think it is in the wording of the answer: A) may have credit policies that are too strict. (note the use of the word may) compared to C) makes less credit sales than the average firm in its industry. (which does not use the word may and is definite) Yeah so it would have to be A If C was worded “may make less credit sales blah blah” then it would also be correct
Yea…i guess its the wording that makes the difference… Thanks for the explanation everyone!