Chapter 13, Problem 8E

To determine

Compute (1) days’ sales uncollected, (2) accounts receivable turnover, (3) inventory turnover, and (4) days’ sales in inventory. Comment on the changes in the ratios from 2016 to 2017.

Explanation of Solution

(1) Days’ sales uncollected: This ratio is used to determine the number of days a particular company takes to collect accounts receivables.

$\text{Days’ sales uncollected}\text{=}\frac{\text{Ending accounts receivable}}{\text{ Sales}}\times 365\text{days}$

For 2016:

$\begin{array}{c}\text{Days’ sales uncollected}\text{=}\frac{\$62,500}{\$532,000}\times 365\text{days}\\ =42.9\text{days}\end{array}$

For 2017:

$\begin{array}{c}\text{Days’ sales uncollected}\text{=}\frac{\$89,500}{\$673,500}\times 365\text{days}\\ =48.5\text{days}\end{array}$

(2) Accounts receivable turnover: Receivables turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. This ratio is determined by dividing credit sales and average accounts receivable.

$\text{Receivables Turnover Ratio}\text{=}\frac{\text{Net Sales}}{\text{Average}\text{Accounts}\text{Receivables}}$

For 2016:

$\begin{array}{c}\text{Receivables Turnover Ratio}\text{=}\frac{\$532,000}{\left(\$62,500+\$50,200\right)÷2}\\ =9.4\text{times}\end{array}$

For 2017:

$\begin{array}{c}\text{Receivables Turnover Ratio}\text{=}\frac{\$673,500}{\left(\$89,500+\$62,500\right)÷2}\\ =8.9\text{times}\end{array}$

(3) Inventory turnover: Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.

$\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold }}{\text{Average Inventory}}$

For 2016:

$\begin{array}{c}\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold }}{\text{Average Inventory}}\\ =\frac{\$345,500}{\left(\$82,500+\$54,000\right)÷2}\\ =5.1\text{times}\end{array}$

For 2017

$\begin{array}{c}\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold }}{\text{Average Inventory}}\\ =\frac{\$411,225}{\left(\$112,500+\$82,500\right)÷2}\\ =4.2\text{times}\end{array}$

(4) Days’ sales in inventory: Days’ in inventory is determined as the number of days a particular company takes to make sales of the inventory available with them.

$\text{Days’ in inventory}\text{=}\frac{\text{Ending}\text{Inventory}}{\text{Cost of goods sold}}\times 365\text{days}$

For 2016:

$\begin{array}{c}\text{Days’ in inventory}\text{=}\frac{\text{Ending}\text{Inventory}}{\text{Cost of goods sold}}\times 365\text{days}\\ \text{= }\frac{\$82,500}{\$345,500}\times \text{365}\text{days}\\ \text{=}\text{87}\text{.2 days}\end{array}$

For 2017:

$\begin{array}{c}\text{Days’ in inventory}\text{=}\frac{\text{Ending}\text{Inventory}}{\text{Cost of goods sold}}\times 365\text{days}\\ \text{= }\frac{\$112,500}{\$411,225}\times \text{365}\text{days}\\ \text{=}99.\text{9 days}\end{array}$

Analysis and comment on changes:

Days’ sales collection ratio is increased and accounts receivable turnover ratio is decreased from 2016 to 2017. Inventory turnover ratio is decreased and days’ sale in inventory is increased from 2016 to 2017.

The above ratios indicate that the Company S is becoming inefficient in collection of account receivables and managing the inventory.