Question

True or False. A company with a low accounts receivable turnover ties up a smaller proportion of its funds in accounts receivable than a company with a high turnover.

Answer 1

False.

Accounts Receivable Turnover(now on referred to as "ACT", for brevity) is an activity ratio. It is a measure used to quantify a firm's effectiveness in extending credit and in collecting debts on that credit. It is calculated by dividing the net credit sales during a given period by the average accounts receivable during the same period. It is mostly calculated annually. ACT indicates the efficiency with which a firm collects the accounts receivables.

By allowing sales on credit to it's customers, the firm is indirectly extending loans without interest to the customers. As a result, the firm loses money the longer it takes to collect the receivables. So the firm would would want to collect it's receivables quicker because it cannot use the its funds optimally, if it is tied up in outstanding receivables. ACT measures the number of times the firm has collected it's accounts receivables in the past year. A higher ACT signifies quicker collection of receivables, thereby releasing more funds for the utilization of the firm. Hence the statement is incorrect.