302826 Liquidity Ratio 1F Flashcards
The average collection period for receivables is a measure of:
sales performance.
asset value.
liquidity.
leverage.
Question #302826
liquidity.
Liquidity ratios measure a company’s ability to pay its current liabilities. The average collection period, also called Accounts Receivable turnover, measures how quickly a company receives payment on its receivables (from customers), so the metric measures how quickly accounts receivable is being converted to cash. Cash is used to satisfy most current liabilities.
The average collection period does not measure asset value, leverage, or sales performance. Sales performance relates to profitability, leverage involves measuring the percentage of assets financed by debt, and asset value includes measuring assets at fair market value, which are all factors not relevant to the collection of the average collection period.
Activity Ratio
Activity ratios are ratios that measure the efficiency with which the firm uses its resources. They are ratios that compare various asset amounts to the level of sales, and assume that a proper balance should exist between sales and assets. Activity ratios reflect returns.
Activity ratios include the following:
- Accounts Receivable Turnover
- Average Collection Period
- Inventory Turnover
- Fixed Assets Turnover
- Total Assets Turnover
Leverage (Total)
Total leverage is a combination of operating and financial leverage. If a company used both high degrees of operating and financial leverage, only small changes in sales will result in large fluctuations in EPS (earnings per share). This can be shown in equation form:
Liquidity
Liquidity is the convertibility of an entity’s assets into ready cash to meet current obligations. Liquid assets are cash on hand and in banks and marketable securities readily convertible into cash.
Ratios, computational issues, and analysis
2161.03 Current ratio
2161.03 Acid-test (or quick) ratio
2161.03 Average collection period (or days sales outstanding)
Inventory turnover
