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9.3 Determine the Efficiency of Receivables Management Using Financial Ratios

Receivables Management Ratios​

Financial ratios help measure how efficiently a business manages its receivables. Two key ratios are:

  1. Accounts Receivable Turnover Ratio
  2. Average Collection Period (Days Sales Outstanding)

Accounts Receivable Turnover Ratio​

Formula: Accounts Receivable Turnover = Net Credit Sales ÷ Average Accounts Receivable

What it Measures:

  • How many times receivables are collected during the period
  • Higher ratio = faster collection = better

Calculation:

  • Net Credit Sales: Total credit sales (excluding cash sales)
  • Average Accounts Receivable: (Beginning Receivables + Ending Receivables) ÷ 2

Example:

  • Net Credit Sales: €120,000
  • Beginning Accounts Receivable: €10,000
  • Ending Accounts Receivable: €14,000
  • Average: (€10,000 + €14,000) ÷ 2 = €12,000
  • Turnover: €120,000 ÷ €12,000 = 10 times

Interpretation:

  • Receivables collected 10 times during the year
  • Good turnover (depends on industry)

Average Collection Period (Days Sales Outstanding)​

Formula: Average Collection Period = 365 Days ÷ Accounts Receivable Turnover

Or: Average Collection Period = (Average Accounts Receivable ÷ Net Credit Sales) × 365

What it Measures:

  • Average number of days to collect receivables
  • Lower number = faster collection = better

Example:

  • Accounts Receivable Turnover: 10 times
  • Average Collection Period: 365 ÷ 10 = 36.5 days

Interpretation:

  • Takes average of 36.5 days to collect receivables
  • Reasonable for many businesses

Industry Benchmarks​

Typical Collection Periods:

  • Retail: 30-45 days
  • Wholesale: 30-60 days
  • Services: 30-60 days
  • Manufacturing: 45-60 days

Luxembourg Context:

  • Varies by industry
  • B2B typically 30-60 days
  • B2C often shorter
  • International customers may be longer

Improving Receivables Management​

Strategies to Improve:

  1. Credit Policies

    • Check creditworthiness before extending credit
    • Set appropriate credit limits
    • Clear payment terms

  2. Collection Procedures

    • Send invoices promptly
    • Follow up on overdue accounts
    • Offer early payment discounts
    • Charge late fees

  3. Monitoring

    • Regular aging reports
    • Monitor collection period
    • Identify problem accounts early

  4. Customer Relations

    • Maintain good relationships
    • Communicate clearly
    • Resolve disputes quickly

Luxembourg Considerations​

Payment Terms:

  • Common: 30 days, 60 days
  • May vary by customer
  • International customers may have longer terms

Collection Challenges:

  • Cross-border collections
  • Different payment methods
  • Currency considerations
  • Legal differences

Luxembourg Compliance Note​

Receivables management in Luxembourg:

  • Must monitor for bad debts
  • Must estimate allowances properly
  • Must comply with collection laws
  • Must handle VAT correctly
  • Must maintain proper documentation

Think It Through​

A business has an average collection period of 60 days, but its payment terms are 30 days. What does this indicate, and what actions should be taken?