Assume that Hickory Copany has the following data related to its accounts receivable:
2005 2006
net sales $1,425,000 $1,650,000
net receivables
beginning of 2005:375,000
beginning of 2006:333,500
end of 2005:420,000
end of 2006:375,000
Use these data to compute accounts receivable turnover ratios and average collection periods for 2005 and 2006. Based on your analysis, is Hickory Company managing its receivables better or worse in 2006 than it did in 2005?
To compute the accounts receivable turnover ratio and average collection period, we need to use the formula mentioned below:
Accounts Receivable Turnover Ratio = Net Sales / Average Accounts Receivable
Average Collection Period = 365 days / Accounts Receivable Turnover Ratio
Now, let's calculate the accounts receivable turnover ratio and average collection period for 2005 and 2006.
For 2005:
Net Sales = $1,425,000
Average Accounts Receivable = (Beginning of 2005 + End of 2005) / 2 = ($375,000 + $420,000) / 2 = $397,500
Accounts Receivable Turnover Ratio (2005) = $1,425,000 / $397,500 = 3.58 times
Average Collection Period (2005) = 365 days / 3.58 times = 101.96 days (rounded to 2 decimal places)
For 2006:
Net Sales = $1,650,000
Average Accounts Receivable = (Beginning of 2006 + End of 2006) / 2 = ($333,500 + $375,000) / 2 = $354,250
Accounts Receivable Turnover Ratio (2006) = $1,650,000 / $354,250 = 4.65 times
Average Collection Period (2006) = 365 days / 4.65 times = 78.49 days (rounded to 2 decimal places)
Now, let's analyze the results:
In 2006, Hickory Company has a higher accounts receivable turnover ratio (4.65 times) compared to 2005 (3.58 times). This indicates that the company is collecting its accounts receivable more frequently in 2006.
Furthermore, the average collection period for 2006 (78.49 days) is lower than in 2005 (101.96 days). This signifies that on average, Hickory Company is collecting its accounts receivable faster in 2006.
Based on this analysis, we can conclude that Hickory Company is managing its receivables better in 2006 compared to 2005, as it has a higher turnover ratio and a shorter average collection period, indicating improved efficiency in collecting accounts receivable.