Collection ratio can be calculated by the formula:

Question

Options

• ACollection Ratio = 365 / Payable Turnover
• BCollection Ratio = 365 + Net Income / Receivable Turnover
• CCollection Ratio = 365 / Receivable Turnover
• DCollection Ratio = 365 + Net Sales / Receivable Turnover

• A
  4% (2)
• B
  9% (5)
• C
  83% (44)
• D
  4% (2)

Explanation

Option C is correct because the Collection Ratio (also called Days Sales Outstanding) measures how many days on average a company takes to collect its receivables - calculated by dividing 365 days by the Receivable Turnover ratio, which tells you how frequently receivables are collected in a year.

Option A is wrong because it uses Payable Turnover instead of Receivable Turnover - that formula calculates the Days Payable Outstanding (how long a company takes to pay its own bills), not the collection period. Options B and D are nonsensical because they use addition (+) instead of division (/); adding 365 to a ratio produces a meaningless number, whereas dividing converts the turnover rate into a number of days.

Memory tip: Think of it as "flipping the frequency into days" - if you collect receivables 5 times a year, you collect every 365 ÷ 5 = 73 days. The word collection in "Collection Ratio" is your cue to use Receivable (not Payable) Turnover.

No community discussion yet for this question.