Is an increase in collection period necessarily bad? Explain.
yes,
but if an increase in collection period is compensated by an increase in how long you take to pay your creditors, then it's not so bad. The worst case is if you have to pay your creditors cash on delivery but your debtors take months to pay you. In that case, you're financing your debtors. You need to be tougher on your debtors.
Receivables is a reliable means of helping to determine whether it is a good investment play or not. Companies stay efficient and competitive by keeping inventory levels down and speeding up collection of what they are owed. In this article, we’ll take you through the process step by step.
Well, you know what they say, "patience is a virtue." So I suppose if you have to wait longer to collect on something, it's a great opportunity to practice being virtuous! But on a more serious note, an increase in collection period can actually be a sign of trouble. It means that it's taking longer for a company to collect the money it's owed, which could indicate cash flow problems or issues with customer payments. In the world of business, timely collection is kind of like getting a good punchline - you want it to come quickly and with maximum impact!
An increase in collection period refers to the amount of time it takes for a company to collect payment from its customers for goods or services provided. Whether an increase in collection period is necessarily bad depends on the specific circumstances of the company. Here are some factors to consider:
1. Cash flow: If the increase in collection period leads to a cash flow problem, where the company is unable to meet its short-term financial obligations, then it can be considered bad. This situation can arise if the company relies heavily on timely payments from customers to cover its own expenses.
2. Working capital: A longer collection period means that funds are tied up in accounts receivable, which can negatively impact a company's working capital. This can limit the company's ability to invest in new projects or fund its day-to-day operations.
3. Profitability: If the increase in collection period results in a significant increase in bad debt or uncollectible amounts, then it can lead to lower profitability for the company. This is because the company will have to write off these unpaid amounts as expenses, reducing its overall profits.
4. Relationship with customers: A longer collection period may strain the relationship between the company and its customers. It can create dissatisfaction and lead to customer loss if customers perceive the company as being inflexible or difficult to work with.
However, there can also be situations where an increase in collection period can be considered favorable:
1. Strategic reason: The increase in collection period could be a deliberate strategy employed by the company to help attract customers or gain a competitive advantage. For example, offering extended credit terms might be an incentive for customers to choose the company over its competitors.
2. Industry norms: In some industries, longer collection periods are common practice. If a company's collection period aligns with industry norms, it may not necessarily be bad.
Ultimately, the impact of an increase in collection period on a company's financial health and performance will depend on various factors, such as the company's financial situation, industry dynamics, and strategic objectives.
In order to determine whether an increase in collection period is necessarily bad, we first need to understand what collection period refers to. The collection period measures the average number of days it takes for a company to collect cash from its customers after a sale has been made.
Now, let's explain how to analyze the impact of an increase in collection period:
1. Assess the impact on cash flow: An increase in collection period means that cash inflow from customers is delayed, which can have a negative impact on a company's cash flow. If a company relies heavily on timely cash inflows to cover its expenses, such as paying suppliers or investing in new projects, an increase in collection period can strain its finances and potentially create liquidity issues.
2. Evaluate the impact on working capital: Working capital represents a company's short-term funding needs to support day-to-day operations. An increase in collection period leads to a longer operating cycle, which means that funds remain tied up in accounts receivable for a longer period of time. This can increase the company's need for external financing to bridge the gap, potentially increasing interest expenses or diluting ownership through equity financing.
3. Consider the impact on customer relationships: A longer collection period may also signal potential issues with customers' ability to pay or their willingness to honor payment obligations. It can strain customer relationships and potentially lead to disputes or loss of business if customers seek alternatives that offer better payment terms.
While an increase in collection period is generally seen as unfavorable, it's important to consider the context and industry norms. Some industries naturally have longer collection periods due to the nature of their business or the market conditions they operate in. For example, companies in the construction industry often have longer collection periods compared to retailers.
In conclusion, an increase in collection period can have negative implications on a company's cash flow, working capital, and customer relationships. However, the impact may vary depending on the specific circumstances and industry norms. It's important for a company to monitor and manage its collection period effectively to mitigate any potential drawbacks.