Financial Reporting and Ethics - The Institute of Chartered ...

ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTSAverage DebtorsCredit Salesx 100%Where average debtors = Opening Debtors + Closing Debtors2However, a rough estimate of the average length of time it takesa company’s debtors to pay is expressed as:Debtors x 365 daysSalesThe average collection period measures the quality of debtorssince it indicates the speed of collection. The shorter the collectionperiod, the better the quality of the debtors to a firm. Anexcessively long collection period implies a very inefficientcollection performance. However, this should not be taken as ahard and fast rule for the purpose of interpretation as other factorsmay need to be considered before taking a financial decision.The collection period, therefore, helps in determining thefollowing:(i)(ii)The collectability of debts, and, thus, the efficiency ofcollection efforts, andThe company’s comparative strength and advantagerelative to its credit policy and performance vis-à-vis thecompetitors’ credit policies and performance. Debtors’collection may not necessarily be expressed in terms oflength of time but also in terms of velocity to pay. Debtors’collection expressed in terms of velocity (i.e. rate ofcollection) is called Debtors’ Turnover.Debtors’ Turnover = Credit SalesAverage DebtorsORSalesDebtorsDebtors’ turnover indicates the number of times debtors areturned over each year. Generally, the higher the value of debtors’turnover, the more efficient is the management of credits.It must be noted that debtors’ collection period or debtors’turnover measures the quality of debtors in an aggregative way.(e)Creditors’ Payment Period77