The correct option is this 73 days.
Average Collection Period (Days Sales Outstanding) in Finance MCQs
In Finance MCQs, the Average Collection Period (ACP)—also commonly known as Days Sales Outstanding (DSO)—is an important financial metric used to evaluate how efficiently a company...
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The correct option is this 73 days.
Average Collection Period (Days Sales Outstanding) in Finance MCQs
In Finance MCQs, the Average Collection Period (ACP)—also commonly known as Days Sales Outstanding (DSO)—is an important financial metric used to evaluate how efficiently a company manages its accounts receivable. It measures the average number of days a company takes to collect cash from customers after making a credit sale. This ratio plays a crucial role in assessing a firm’s liquidity, credit management practices, and overall operational efficiency. Because receivables represent money owed to the company, the speed at which they are converted into cash directly affects the firm’s ability to meet short-term obligations and maintain smooth business operations.
The formula for calculating the average collection period is:
Average Collection Period=Net Credit SalesAverage Accounts Receivable×365
This formula expresses the relationship between the amount of money tied up in receivables and the total sales generated over the year. By multiplying the ratio by 365 days, the calculation converts the fraction into the number of days it typically takes for the company to collect payment.
Given the values in the question:
Average Accounts Receivable = Rs. 150,000
Net Sales = Rs. 750,000
Substituting these values into the formula:
Average Collection Period=750,000150,000×365
=0.2×365
=73 days
This means that, on average, the company takes 73 days to collect payments from its customers. In practical terms, after making a credit sale, the firm must wait about two and a half months before receiving the cash. Finance MCQs often include such numerical calculations to test students’ understanding of receivables management and financial ratio interpretation.
The average collection period is widely used in financial analysis and working capital management because it provides insights into how effectively a company manages its credit policies and cash flows.
1. Liquidity and Cash Flow Management
Companies require cash to pay suppliers, employees, and other operational expenses. If the collection period is too long, the company may face liquidity problems even if sales are strong. Efficient receivable collection ensures that cash flows remain steady and operations continue smoothly.
2. Evaluation of Credit Policy
The ratio helps managers evaluate whether their credit terms are appropriate. For example, if a company offers customers 30-day credit but the average collection period is 73 days, it indicates that customers are paying late. This may prompt the company to tighten credit policies or improve collection procedures.
3. Benchmarking and Performance Comparison
Businesses often compare their collection period with industry averages or with competitors. If a company’s collection period is significantly longer than the industry norm, it may indicate inefficiency in receivables management or weaker customer credit control.
4. Working Capital Efficiency
Accounts receivable are part of working capital, and efficient management of receivables improves the overall financial health of the firm. Reducing the collection period frees up cash that can be used for reinvestment, expansion, or debt reduction.
The average collection period is closely related to the Accounts Receivable Turnover Ratio, which measures how many times a company collects its receivables during a year:
Accounts Receivable Turnover=Average Accounts ReceivableNet Credit Sales
The two ratios are inversely related. In fact, the average collection period can also be calculated as:
Average Collection Period=Accounts Receivable Turnover365
This relationship is often tested in Finance MCQs to ensure students understand both formulas and how they connect.
In the given question, other possible answers such as 5 days, 36 days, and 48 days are incorrect because they do not match the ratio of receivables to sales. These values underestimate the time required for collections based on the provided financial data.
The Average Collection Period measures the average number of days a company takes to collect payments from its customers. Using the given values of Rs. 150,000 in average accounts receivable and Rs. 750,000 in net sales, the calculation shows that the company takes 73 days to collect its receivables. Understanding this ratio is essential for Finance MCQs because it helps evaluate credit policies, liquidity management, and operational efficiency in corporate financial analysis.
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