What does it mean when a firm has a days' sales in receivables of 45?

• A. The firm writes off uncollectible accounts every 45 days.
• B. The firm grants 45 days of credit to all customers.
• C. On average, it takes the firm 45 days to collect cash from its credit sales.
• D. The firm collects 45% of its receivables each month.

Answer: (C)

Verified step by step guidance

1. Understand the concept of 'days' sales in receivables': This metric, also known as the average collection period, measures the average number of days it takes for a company to collect cash from its credit sales. It is a key indicator of the firm's efficiency in managing accounts receivable.
2. Clarify the meaning of 45 days: If a firm has a days' sales in receivables of 45, it means that, on average, it takes the firm 45 days to collect cash from its credit sales. This does not imply that the firm writes off uncollectible accounts every 45 days or grants 45 days of credit to all customers.
3. Distinguish between the options provided: The correct interpretation is that the firm takes 45 days to collect cash from its credit sales. The other options provided in the problem are incorrect interpretations of the metric.
4. Relate this metric to financial performance: A shorter collection period generally indicates better efficiency in managing receivables, while a longer period may suggest potential issues with credit policies or customer payment behavior.
5. Consider the implications for decision-making: Firms use this metric to assess their credit policies and cash flow management. If the days' sales in receivables is too high, it may signal the need to tighten credit terms or improve collection efforts.