Question

Houston House (Pty) Ltd and Whitney Holdings are competitors in the same industry.

The following information was summarised from a recent annual report of Houston House (Pty) Ltd

(In millions)

Receivables:

December 31, 2015 R 1,968

December 31, 2014 642

Revenue for the year ended:

December 31, 2015 46,980

December 31, 2014 40,023

The following information was summarised from a recent annual report of Whitney Holdings:

(In millions)

Accounts and notes receivable, net

December 31, 2015 R 246

December 31, 2014 264

Revenues for the year ended:

December 31, 2015 4,335

December 31, 2014 4,251

Required:
1. Calculate the accounts receivable turnover ratios for Houston House and Whitney Holdings for the most recent year.
2. Calculate the average collection period, in days, for both companies for the most recent year. Comment on the reasonableness of the collection periods for these companies considering the nature of their business.
3. Which company appears to be performing better? What other information should you consider in determining how these companies are performing?

Answer 1

Q (b) Answer

The Average Collection period represents the time period (in days) that it takes a business to collect its Receivables.

From the answer for Average Collection Period, it is clear that Houston House (Pty) Ltd. is able to collect its receivables on an average of 10.14 days, as compared to 21.14 days for Whitney Holdings.

It can also be noted that Houston House (Pty) Ltd is a much larger entity when compared to Whitey Holdings. Though they are in the same industry, they are not exactly competitors, as the scale of operations of Houston House (Pty) Limited is obviously bigger.Comparison will serve its purpose, if companies in the same industry, and of similar scale or size, are compared.

Comparison of Average Collection Period over a limited time horizon of one (1) year is not an effective yardstick to measure performance. Average Collection Period has to be measured over a period of time, say 5 years or more, for a trend to manifest.

It can also be observed that:

i. While the Revenues of Houston House (Pty) Ltd has grown 17%, its Receivables has more than trebled (300%). This shows a deteriorating ability to collect its Receivables in 2015;

ii. In contrast, though Whitney Holdings' Revenues has grown only by 2%, its Receivables has reduced in 2015 as compared to 2014. This shows that company has been able to improve on its ability to collect its Receivables, albeit marginally.

Q 3 Answer

From the ratios computed in the answer table, it is clear that Houston House (Pty) Ltd is, prima facie, performing better in comparison to Whitney Holdings.

However, it should be note that though both are in the same industry, they are not exactly competitors. Houston House (Pty) Limited is definitely a bigger entity, based on revenues, as compared to Whitney Holdings.

A higher Receivables Ratio indicates the following:

a. Company operates on cash basis. It has to be observed that total revenue data has been provided, rather than credit sales. It is assumed that Revenues = Cedit Sales. This assumption may not be true.

b. Houston House (Pty) Ltd's collection of Receivables is efficient in comparison to Whiteny Holdings for the year 2015. A clear trend would emerge, if Revenue and Receivables of a longer time horison are provided. Houston House (Pty) Ltd could also be having a higher proportion of quality customers who pay their dues on time.

c. Houston House (Pty) Ltd's credit policy could be conservative, when compared to Whitney Holdings.

However, the Receivables Turnover has some limitations. To be able to compare performance between Houston House (Pty) Ltd and Whitney Holdings, it has to be noted that:

1. Revenue could represent total revenue instead of net revenues. Houston House (Pty) Limited could be using Total Revenues, and this could inflate their Revenue figure. Whitney could be reporting the Net Revenue data.

2. The average receivables does not reflect the can vary widely during a year. Taking an average based on Begining balance of Receivables and Ending Balance of Receivables does not provide a true picture of collection efficiency.

3. Comparisons serve a purpose when they are made between firms in the same industry, similar sales values, similar business models, and capital structure.

4. Time horizon of one (1) year is very limited. A longer time horizon for comparison will yield better results.

5. To make an effective comparison, it would be ideal to use more data like Fixed Assets Turnover, Inventory Turnover and other Turnover ratio to make a better comparison.