The following are the two ratios discussed in your text with respect to analysis

Question

The following are the two ratios discussed in your text with respect to analysis of accounts receivable:

A/R turnover ratio = Net Credit Sales/Ave. Net A/R

Days in A/R = 365/AR turnover ratio

In most cases, companies do not disclose "credit sales" separately from "cash sales" in their annual report. Thus Net Sales [or Net Revenues] is frequently used in the A/R turnover ratio. For example, a restaurant company's A/R turnover ratio = 51.2 [excessively high, as mainly cash sales, as remember credit card sales are treated as cash sales].

The prior question illustrates that you need to be careful when doing ratio analysis, as sometimes results can be misleading. Which one of the following statements is incorrect (false)?

A. Generally ratio analysis can be performed appropriately when comparing the same company from year to year [time-series analysis].
B. Generally ratio analysis can be performed appropriately by comparing companies in the same industry [cross-sectional analysis]
C. You would expect the "Days in A/R" you calculated for in the prior question (i.e. for a restaurant company) to be a larger number than for 3M (a manufacturer), which has a much larger percentage of credit sales [to total sales].
D. Given the nature of restaurant business using Total Revenues (rather than Net Credit Sales) is totally inappropriate when performing A/R ratio analysis.

Explanation / Answer

C. You would expect the "Days in A/R" you calculated for in the prior question (i.e. for a restaurant company) to be a larger number than for 3M (a manufacturer), which has a much larger percentage of credit sales [to total sales].

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