Question

1.   Which of the following will extend the cash collection period?

1. Switching from an all cash sales policy to extending accounts receivable with a 30 day net payable period.
2. Switching from an accounts receivable policy that collects in 60 days to a policy that collects in 45 days.
3. Paying suppliers in 60 days, rather than 30 days.
4. All of the above will cause collections to be extended.

Answer 1

• The Cash collection period/ Average collection period is the average number of days between when a sale is made by a company on credit and the receipt of payment from the customer.
• The cash collection period is an important metric and companies should keep a check on it, comparing to its industry benchmark, so as to make sure it is liquid enough to pay off its obligations in case they arise.

In the given question, the option (A) states that currently the firm has an all cash sales property (thus no cash collection period) as the sales are made on cash basis. However, if the firm decides to extend its accounts receivable with a 30 day net payable period, then the firm's customers can pay for the purchases within 30 days, thus increasing/ extending the cash collection period.

Option (B) suggests to reduce the accounts receivable policy from 60 days to 45 days. This means that when first the customers were allowed a 60-day period to pay for purchases, it has now been reduced to 45 days. Thus, customers would have to make payments within 45 days, indicating a decrease/ contraction in the cash collection period.

The payment to suppliers does not effect the timings of cash collection from customers and thus does not affect the cash collection period.

Hence, the correct answer is option (A).