Would a company that uses a natural business year tend to overstate or understate the liquidity of its receivables? Explain.
T. Melcher Company uses the calendar year. Sales are at a peak during the holiday season, and T. Melcher Company extends 30 day credit terms to customers. Comment on the expected liquidity of its receivables, based on the days’ sales in receivables and the accounts receivable turnover.
A company that uses a natural business year, or ends its year when business is at a peak, will tend to distort the liquidity of its receivables when end of year and beginning of year receivables are used in the computation. Explain how a company that uses a natural business year or ends its year when business is at a peak can eliminate the distortion in its liquidity computations.