Learning more about the significance of Debtors
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By using Ratio Analysis the words in the Balance Sheet and Profit and Loss Account can tell us something about how well the business has performed.
Debtors is used in the Debtors collection ratio (Ratio 6 below) and can therefore tell us something about the efficiency of the business.
The higher the figure the longer debtors take to pay up.
In other words the lower the ratio the better i.e. Big is Bad.
The ratio can be expressed  in terms of the number of days, weeks or months that debtors take to pay for goods and services.
Other common ratios are also listed below .
Profitability
1 Return on Capital Employed  =   Profit            x  100 = %
                                                       Capital

2 Gross Profit Ratio                  =   Gross Profit  x  100 = %
                                                            Sales

3 Net Profit Ratio                      =   Net Profit      x  100 = %
                                                           Sales

Efficiency Ratios
4 Stock Turnover Ratio            =  Cost of Goods Sold =  No of times
                                                          Average Stock

5 Fixed Assets Turnover Ratio =  Sales                       = No of times
                                                        Fixed Assets at NBV

6 Debtor Collection Period        =  Average debtors     x 365  = No of days
                                                                   Sales             x   52  = No of weeks
                                                                                         x  12   = No of months

7 Suppliers Payment Period       =    Creditors               x 365   = No of days
                                                          Purchases               x  52    = No of weeks
                                                                                          x  12    = No of months

8 Asset Turnover                       =      Sales                      = No of Times
                                                     Capital Employed

Liquidity Ratios
9 Current Ratio                          =   Current Assets        = Expressed as a
                                                       Current Liabilities        Factor

10 Quick or Acid Test               =  Current Assets - Stock [Also expressed as a Factor]
                                                        Current Liabilities

Investment Ratios
11. Gearing                                 =  Preference Shares + Long Term Loans    X  100%
                                                        Shareholders funds + Long Term Loans
 
 

A Note of caution:
Ratio Analysis is all about comparing one set of ratios with another.
This can mean comparing one year with another, or comparing the performance of one company with another or with its budgets.
To achieve greater confidence in the conclusions you draw, you really need to compare more values than just two. You also need to bear in mind that there is some flexibility in the accounting treatments adopted by accountants when preparing the financial statements and so differences observed in performance might in part be due to differences in the way items have been treated in the accounts rather than differences in performance.
Now test your understanding by attempting to calculate  the debtors collection period (ratio) from our own figures.
First you need to know whether to examine  the  trading, profit and loss account or the balance sheet.
If you make a mistake you may return here, for another try, by pressing your internet return button. You must return to this point in any event if you wish to take a peep at the answer
 Trading, profit and loss account          Balance sheet

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

answers to debtors collection period
Debtors collection period = debtors    x    365  days  =   304     x  365  = 55 days
                                               sales                                   2,000
This means that on average  customers (debtors) are taking 55 days to pay up.
Note that we have used the balance sheet debtors figure and not an average of the opening and closing debtors. This is because we are not given the opening debtors value and therefor cannot calculate average debtors. When this happens it is perfectly appropriate to use the balance sheet debtors figure which is also referred to as the closing debtors figure.
The sales figure is found on the top of the trading, profit and loss account.

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