DEBTORS TURNOVER RATIO - Accounts and Finance for Managers

Debtor turnover Ratio definition

This ratio exhibits the speed of the collection process of the firm in collecting the overdues amount from the debtors and against Bills receivables. The speediness is being computed through debtors velocity from the ratio of Debtors turnover ratio.

Debtors turnover ratio=Net Credit Sales :Average Debtors

Net Credit Sales :

Debtor + Bills Receivable

Standard norm of the ratio

Higher the ratio is better the position of the firm in collecting the overdue means the effectiveness of the collection department and vice versa.

Debtors Velocity

This is an extension of the earlier ratio to denote the effectiveness of the collection department in terms of duration.

Debtors velocity= 365days/52weeks/12months

Debtor turnover ratio

Standard norm of the ratio

Lesser the duration shows greater the effectiveness in collecting the dues which means that the collection department takes only minimum period for collection and vice versa.

Creditors Turnover Ratio

It shows effectiveness of the firm in making use of credit period allowed by the creditors during the moment of credit purchase.

Creditors Turnover ratio= Credit Purchase : Average creditors

or

Credit Purchase :

Bills payable + Sundry

Standard norm of the ratio

Lesser the ratio is better the position of the firm in liquidity management means enjoying the more credit period from the creditors and vice versa.

Creditors velocity=

365days/52weeks/12months

Creditors Turnover Ratio

Standard norm of the ratio

Greater the duration is better the liquidity management of the firm in availing the credit period of the creditors and vice versa.

Illustration 5

Sundaram &co sells goods on cash as well as credit basis. The following particulars are extracted from the books of accounts for the calendar 2005

particulars are extracted from the books of accounts for the calendar 2005

Debtors Turnover Ratio Problems

Calculate average collection period
To find out the average collection period, first Debtors turnover ratio has to computed

Debtors turnover ratio=Net Credit sales : Bills receivable + Debtors

Net credit sales= Gross sales – cash sales – sales return
= Rs.2,00,000 – Rs.40,000 – Rs.14,000=Rs. 1,46,000

Debtor turnover ratio=

Rs. 1, 46,000 :

Rs. 4,000 + Rs. 18,000

= 6.64 times

Debtors velocity=

365 days : 6.64 times

=55 days

Illustration 6

Find out the value of creditors from the following
Sales Rs. 1,00,000 Opening stock Rs10,000
Gross profit on Sales 10% Closing stock Rs. 20,000
Creditors velocity 73 days Bills payable Rs. 16,000

Note:All purchases are credit purchases
To find out the volume of purchases, the formula of cost of goods sold should taken into consideration
Cost of goods sold = Opening stock +Purchases- Closing stock
X = Rs.10,000 + Y – Rs.20,000
Cost of goods sold = Sales – Gross profit
= Rs.1,00,000 – 10% on Rs 1,00,000
= Rs.90,000

The next step is to apply the found value in the early equation
Purchases = Rs.90,000 – Rs.10,000 +Rs.20,000
= Rs.1,00,000
To find out the value creditors, the creditor velocity and creditors turnover ratio

Creditors velocity=

365days
Creditors Turnover Ratio

Creditors Turnover ratio=

Credit Purchase
Bills payable + Sundry creditors

=

Rs.1,00,000
Rs.16,000 +Sundry creditors

The next step is to find out the sundry creditors, the reversal process to be adopted

73 days=

365 days
Creditors turnover ratio

Creditors turnover ratio=

365 days
73 days

=5 times

The next step is to substitute the found value in the equation of creditors turnover ratio

Rs. 16,000 + Sundry creditors=

Rs. 1,00,000
5

Sundry creditors= Rs. 20,000 – Rs. 16, 000= Rs. 4,000

Illustration 7

From the following information, prepare a balance sheet show the workings

working capital Rs. 75,000
Reserves and surplus 1,00,000
Bank overdraft 60,000
Current ratio 1.75
Liquid Ratio 1,15
Fixed assets to proprietors’ fund .75
Long term liabilities Nil
First step is to find out the current liabilities

Current ratio=

Current assets
Current liabilities=1.75

1

Working capital = Rs. 75,000 =1.75–1= 0.75
If 0.75 is the share of working capital, what would be the share of current assets?

Current assets=Rs. 75,000× 1.75/.75= Rs.1,75,000


Working capital = Current assets – current liabilities
Current liabilities = Current assets – working capital
CL= Rs. 1, 75, 000 – Rs. 75, 000=Rs. 1, 00, 000
Quick assets ratio = 1. 15=

1.15 = Quick assetsQuick liabilities

=

Quick assets
Current liabilities – BOD

1.15(Rs.1,00,000–Rs.60,000) = Quick assets
1.15(Rs.40,000)= Quick assets
Rs46, 000= Quick assets

The next step is to find out the amount of the closing stock. This can be found out through finding out the difference in between the current assets and quick assets.
Closing stock = Current assets – Quick assets
= Rs.1,75,000 – Rs.46,000= Rs.1,29,000

The next one is to find out the proprietors’ fund
The fixed assets to proprietors’ fund is 0.75
This has to be found out on the basis of Double Entry Accounting Concept
Total liabilities = Total Assets....................(1)
Long term funds + Short term financial resources = Total liabilities
In the long term funds, there is no long term liabilities, which means the structure of long 5term funds consist of the share holders’funds The share holder funds are known as proprietors’ fund
Short term financial resources are known as current liabilities
Proprietors’ fund + Current liabilities = Total liabilities
Current assets + Fixed assets = Total assets
To substitute the values in the equation (1)
Proprietors’ fund + Current liabilities= Current assets + Fixed assets Ratio Analysis
Proprietors’ fund – Fixed assets= Current assets – Current liabilities
1– 0.75=Rs.1,75,000 – Rs.1,00,000
0.25=Rs.75,000
If 0. 25 is bearing the volume of Rs 75, 000; what would be the volume of investment of fixed assets for 0. 75 and proprietor’s fund for 1

proprietor's fund=Rs.75,000/0.25

= Rs.3,00,000


0.75 portion of the owners’ funds are contributed to fixed assets i.e. 0.75 on Rs.3,00,000
= Rs.2,25,000
To find out the exact share of the equity share capital, the following formula has to be used.
Share holder’s funds = Equity share capital + Reserves and surpluses
In this problem, reserves and surpluses is given
Rs.3,00,000=Equity share capital +Rs1,00,000
Equity share capital= Rs. 2,00,000
The balance sheet of the company as on dated

balance sheet of the company

Illustration 8

Debtors velocity 3 months
Creditors velocity 2 months
Stock velocity 8 times
Capital turnover ratio 2. 5 times
Fixed assets turnover ratio 8 times
Gross profit turnover ratio 25%
Gross profit in a year amounts to Rs.1,60,000. There is no long term loan or overdraft. Reserves and surplus amount to Rs.56,000. Liquid assets are Rs.1,94,666. Closing stock of the year is Rs.4,000 more than the opening stock Bill receivable amount to Rs.10,000 and bills payable to Rs.4,000

Find out
Sales Closing stock
Sundry debtors Fixed assets
Sundry creditors Proprietors’ fund
Draft the balance sheet with as many as details possible.
The first step is to find out the sales
Gross profit ratio = 25%

The total volume of gross profit is given = Rs.1,60,000

GP ratio=Gros Profit*100/Sales 25%=Rs.1,60,000*100/Sales

Sales=Rs.1,60,000/25%= Rs.6,40,000

The next step is to find out the closing stock value
In our problem, two important information given are stock velocity and details about the closing stock in terms of opening stock

Stock velocity = 8 times
Closing stock is Rs. 4, 000 excess of opening stock
The information stock velocity given denotes that the stock turnover ratio.

Stock trunover ratio=cost of goods sold/AverageStock

Now the volume of cost of goods sold has to be found out from the early available information i.e., sales and gross profit
Cost of goods sold= Sales – Gross profit= Rs.6,40,000 – Rs.1,60,000= Rs.4,80,000

The next step is to find out the volume of average stock through the earlier formula

8 times=Rs.4,80,000/AverageStock

Average stock = Rs. 60,000
The next step is to apply the conditionality with regards to closing stock

Rs.60,000=Opening Stock + Closing Stock/2

Rs.60,000=Opening Stock + opening stock+4000/2

2 Opening stock +Rs.4,000= Rs.1,20,000
2 Opening stock = Rs.1, 20,000 – Rs.4,000
Opening stock = Rs. 58,000
Closing stock = Opening stock + Rs.10,000= Rs. 58,000+ Rs. 10,000=Rs. 68,000

The next fact is to be found that sundry debtors
To find out the debtors, the most information given debtors velocity and bills receivable have to be made use of

debtors velocity

Sundry debtors = Rs. 1,60,000–Rs. 10,000= Rs. 1,50,000

The next important stage is to find out the sundry creditors
To find out the sundry creditors, the creditors velocity has to be applied in the formula
In addition to the earlier, one missing information has to be found out i-e Credit purchases
The volume of purchase to be found out through the formula of cost of goods sold
Cost of goods sold= Opening stock +Purchases – Closing stock
Rs.4,80,000 = Rs.58,000+Purchases – Rs.68,000
Purchases = Rs.4,80,000–Rs.58,000+Rs.68,000
= Rs.4,80,000+Rs.10,000= Rs.4,90,000

creditors velocity


Rs.4,000+ Sundry creditors= Rs.81,667
Sundry creditors = Rs 77,667

The next step is to find out the volume of fixed assets
This could be found out with the help of fixed assets turnover ratio =5 times

Fixed assets turnover ratio = 5 times=Sales/Fixed assets=Rs.6,40,000/5 times=Rs.1,28,000

Proprietors’ fund
Proprietor’s fund = Fixed assets+ Current Assets – Current liabilities
The above equation is coined on the basis of Double accounting concept
Fixed assets + Current assets = Total assets = Total Liabilities
Total Assets – Current liabilities = Total Liabilities – Current liabilities
Current assets volume is not known, In such cases the stock volume should be added with the Liquid assets to derive the early mentioned.
Current assets= Closing stock + Liquid Assets= Rs.68,000+ Rs. 1,94,666 = Rs2,62,666
Proprietor’s fund = Rs.1,28,000+ Rs.2,62,666 – Rs.81,667= Rs.3,08,999
Share capital = Proprietor’s fund – Reserves and surpluses= Rs.3,08,999 – Rs.56,000= Rs.2,52,999
Cash and Bank Balances to be found out in the next stage
Liquid Asset = Rs. 1,94,666
Less : Debtors Rs. 1,50,000
Bills receivable 10,000 Rs. 1,60,000
Rs.34,666
From the above found information the detailed balance sheet with as many as information possible to portray
Balance sheet as on dated

Balance sheet

Illustration 9

From the following particulars, prepare trading, profit and loss account and a balance sheet
Current ratio -3
Liquid ratio -1.8
Bank overdraft –Rs. 20,000
Working capital – Rs. 2,40,000 Ratio Analysis
Debtors velocity -1 month ; Gross profit ratio -20%
Proprietary ratio (Fixed assets / share holders’ fund) - .9
Reserves and surpluses -. 25 of share capital
Opening stock – Rs. 1,20,000; 8% Debentures –Rs. 3,60,000
Long term investments –Rs. 2,00,000
Stock turnover ratio -10 times
Creditors velocity -1/2 month
Net profit to share capital -20%
First step is to find out the current assets and current liabilities through current ratio

Current ratio=Current Assets/Current Liabilities=3

Current Assets- Current Liabilities = Working capital
3 – 1 = 2 = Rs.2,40,000
The volume of working capital Rs 2,40,000 is equated to share 2
What is the volume of current liabilities for the share of 1

Current Liabilities=Rs.2,40,000/2=Rs.1,20,000


The volume of current assets = Rs. 1,20,000* 3= Rs. 3,60,000
The next step is to find out the volume of liquid assets

Liquid assets ratio =1.8=

Liquid assetss
Liquid Liabilities

When the Bank overdraft is given, the liquid liabilities should be computed.
Liquid liabilities = Current liabilities – Bank overdraft= Rs.1,20,000 – Rs.20,000 = Rs.1,00,000
Liquid assets is 1.8 times greater than the Liquid liabilities
Liquid assets = 1.8 * Rs. 1,00,000 = Rs. 1,80,000
To find out the volume of the stok
Stock = Current assets – Liquid assets=Rs. 3,60,000 – Rs.1,80,000= Rs.1,80,000
The next step is to find out the cost of goods sold
To find out the cost of goods sold, the stock turnover ratio has to be found out

10 times=cost of goods sold +Average stock/Average stock=Opening stock + Closing stock/2=Rs.1,20,000 + Rs.1,80,000/2=Rs.1,50,000

Cost of goods sold = Rs. 1,50,000 × 10= Rs. 15,00,000
Next step is to find out the volume of sales in order to find out the volume of debtors
The volume of sales could be found out through Gross profit ratio
Sales – Profit = Cost of goods sold
100 – 20=80
The Rs15, 00, 000 worth of cost of goods sold is equated to share of 80
What would be the volume of sales?

sales=Rs.15,00,000/80=Rs.18,75,000

Gross profit = Rs. 18,75,000 – Rs. 15,00,000= Rs.3,75,000
The next step is to find out the volume of debtors
The debtors could be found out with the help of debtors turnover ratio and collection period

debtors turnover ratio and collection period

The next step is to find out the creditors. The volume of creditors; to find out the volume of the creditors, the creditors turnover ratio and creditors average payment period should have to be applied

creditors average payment period

Now the volume of credit purchase to be found out with the help of cost of goods sold formula
Cost of goods sold= Opening stock+ Purchases- Closing stock
Rs.15,00,000–Rs.1,20,000+Rs. 1,80,000= Purchases
Rs.15,60,000 = Purchases
Average creditors = Rs.65,000
The next step is to find out the proprietary fund; this could be found out by using the ratio proprietary fund to fixed assets ratio
Total Assets= Total Liabilities
Long term liabilities + Short term liabilities = Fixed assets + Current assets + Investments
Share holders’ fund – Fixed assets = Current assets + Investment – Current liabilities– Debenture
1– 0.9= Rs.2,00,000+Rs.3,60,000–Rs.1,20,000–Rs.3,60,000
1– 0.9= Rs.80,000
0.1=Rs.80,000
If 0.1 share is the volume of Rs.80,000 what is the volume of proprietary fund for the share of 1?
The volume of proprietary fund = Rs.8,00,000
The volume of fixed assets = Rs.80,000× 0.9= Rs.7,20,000
The next step is to find out the volume of the share capital. This could be found out only with the help of the ratio given Reserves and surpluses to share capital
Reserves and surpluses = 25 % of share capital
It means that % is Share capital.
Share capital + Reserves and surpluses = Shareholders’ fund
100+25=125
To find out the share of share capital from the shareholders’ fund, the following is the computation

share capital=Rs.8,00,000*100/125= Rs.6,40,000

Reserves and surpluses = 25% on the Share capital= 25% on Rs.6,40,000 =Rs.1,60,000
The last step is to find out the Net profit, which could be found out through the Net profit to share capital
Net profit is 20% on share capital
Net profit = 20% on Rs.6,40,000= Rs.1,28,000
Next stage is to prepare the Trading, Profit & Loss A/c for the year ended and Balance sheet as on dated
Trading Profit & Loss Account for the year ended

Trading Profit

Balance sheet as on dated


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