ABA ABA Credit & Collections Management 1 — Questions and Answers
Question 1: What is the primary purpose of a credit policy in a business?
- To maximize sales without regard to risk
- To establish guidelines for extending credit to customers (Correct answer)
- To eliminate all bad debt expense
- To report credit transactions to the IRS
Correct answer: To establish guidelines for extending credit to customers
A credit policy establishes the guidelines and criteria a business uses when deciding whether to extend credit to customers.
Question 2: Which financial ratio is most commonly used to evaluate a customer's ability to pay short-term obligations?
- Debt-to-equity ratio
- Current ratio (Correct answer)
- Return on equity
- Price-to-earnings ratio
Correct answer: Current ratio
The current ratio (current assets ÷ current liabilities) measures a company's ability to pay its short-term obligations.
Question 3: What does Days Sales Outstanding (DSO) measure?
- The number of days inventory is held before sale
- The average number of days it takes to collect payment after a sale (Correct answer)
- The number of days a business has been operating
- The average daily sales revenue
Correct answer: The average number of days it takes to collect payment after a sale
DSO measures the average number of days it takes a business to collect payment after a sale has been made.
Question 4: A customer's credit application shows a high debt-to-income ratio. What does this indicate?
- The customer is a low credit risk
- The customer has high net worth
- The customer may have difficulty repaying additional debt (Correct answer)
- The customer qualifies for the highest credit limit
Correct answer: The customer may have difficulty repaying additional debt
A high debt-to-income ratio indicates the customer already has significant debt obligations relative to income, suggesting difficulty in taking on more debt.
Question 5: Which of the following is a common method for aging accounts receivable?
- Grouping invoices by customer industry
- Sorting invoices by geographic region
- Categorizing invoices by how long they have been outstanding (Correct answer)
- Organizing invoices by payment method
Correct answer: Categorizing invoices by how long they have been outstanding
Accounts receivable aging categorizes outstanding invoices by how long they have been unpaid (e.g., 0-30 days, 31-60 days, 61-90 days).
Question 6: What is a collection agency in the context of accounts receivable?
- An internal department that processes incoming payments
- A third-party company hired to recover unpaid debts (Correct answer)
- A government agency that enforces tax collections
- A bank that manages business accounts
Correct answer: A third-party company hired to recover unpaid debts
A collection agency is a third-party company that businesses hire to pursue and recover debts that customers have failed to pay.
ABA ABA Credit & Collections Management 1
What is the primary purpose of a credit policy in a business?