Running a Profitable Business Understanding Financial Ratios 24 Average collection period

Financial ratios—such as ROI (return on investment) or ROA (return on assets)— are a valuable tool for measuring a company's progress against a financial goal, a certain competitor, or the overall industry. In this course, professors Jim and Kay Stice explain the financial ratios found on balance sheets, income statements, and cash-flow statements and provide examples from real-world companies such as Walmart, Nordstrom, and McDonald's. They help you understand how to use financial ratios to analyze or benchmark your company against other companies.

Need an overview of the basics? Check out the Stice brothers' introductory course, Accounting Fundamentals.
Topics include:

What are financial statements?
Understanding the DuPont framework
Working with common-size financial statements
Reviewing profitability, efficiency, and leverage ratios
Analyzing potential-pitfall ratio

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Closed Caption:

okay we've calculated how long our
inventory is with us by calculating day
sales and inventory we can do the same
thing with receivables if we sell their
inventory on credit how long until we
can expect to get the cash we may have
terms of net 30 but we can calculate how
close to that net 30 for example we are
getting by calculating an average
collection period there are two steps in
calculating average collection period
just like with inventory the first thing
we do is calculate our accounts
receivable turnover we take our sales
revenue this time remember with
inventory we took cost of goods sold
with accounts receivable we're going to
take our sales number and we're going to
divide that by average accounts
receivable and to review why do we do
average accounts receivable remember
sales occur throughout the year we don't
want to compare sales throughout the
year with cash suitable at the end or a
Cassie Realty beginning it would be nice
if we had an average accounts receivable
balances well and we calculate that by
just taking beginning balance + are
ending balance dividing by two and then
dividing that into our sales revenue in
the case of Nordstrom it turns out that
their accounts receivable turnover is
5.7 and that was what it was in 2012 as
well however note this with Dillard's
Dillard's in 2013 had turned their
accounts receivable over two hundred and
seven times wow what do we do with these
numbers well as we did with inventory
will simply divide them into 365 22 have
a days
measure that we can compute our average
collection period in the case of
Nordstrom take some sixty four days on
average now if their terms are net 30
and it's taking 64 days we would have
questions about that and we could ask
the individual in charge of their credit
policy was to deal here what we would
find is they're charging interest for
people who take longer than 30 days so
Nordstrom collects their receivables on
average in 64 days some people take
longer than that some people take
shorter than that but on average it's 64
days now what's the deal with Dillard's
Dillard's has an average collection
period
divide 207 into 365 of one point eight
days one point eight days that's pretty
quick how do they do that well it turns
out as we mentioned previously dealers
has an arrangement with GE Capital and
GE Capital pretty much handles Dillard's
accounts receivable the only account she
will Dillard's has for the most part is
when they rent space within their store
to like makeup departments and things
like that and they're waiting to collect
on those so dealers
basically from you and me to customer
their average collection period is 0 for
Nordstrom 64 days on average now is it a
big deal
well as talk about the average
collection period in a real-life example
that my brother and I are familiar with
where we're going to school we work for
a small business a group of doctors
three very nice doctors very nice
doctors they were so nice in fact that
they had trouble forcing their credit
customers to pay this was back before
insurance companies would do all that
forum so their accounts receivable
balance back then thirty years ago was
$300,000 in today's dollars that would
be about $700,000 back then their
average collection period was about two
hundred days somebody would come in the
doctor and make them better and 200 days
later they would collect from that but
these doctors were nice what they ended
up having to do if they wanted to get
that money they had to hire somebody who
could be a little more aggressive they
hired an individual whose job it was to
sit on the phone for 20 hours a week and
just call slow paying customers it turns
out that $300,000 they were able to cut
that in half in about six months what
were they able to do it that extra
$150,000 pay back loans by additional
equipment expand their operations it
turns out if money is tied up in
receivables that constrains what you can
do as a business just as when money is
tied up in inventory it constrains what
you can do as a business we need to keep
an eye on how efficiently we are
managing our inventory how efficiently
are met we are managing our receivables
as well