liquidity ratios Flashcards
what should Both the liquidity ratios be compared to
come to last year
what is the formula for current ratio
current asset : current liabilities
what does the current ratio show
?This shows the ability of the business to pay its short term debts using its short-term assets.
what should the ratio or current ratio be
2 : 1
if the current ratio is high
what could be the reason
there is too much stock
wrong stock
prices too high
if the current ratio is low
what could be the reason
the business cannot pay its short-term debts using current assets. It can be due to:
obsolete stock stock
valued higher than realistic value
increase in credit sales (debtors)
hat would you recommend if the current ratio is high
.check stock levels - should not be too high ?
check obsolete stock
?check whether prices are not too high
what is the formula for the acid test ratio
current asset - inventories : current liabilities
what does he acid test ratio show
It shows whether the business can settle its short term debts without having to sell stock
what should the ratio of the acid test ratio be
1 : 1
what is the reason if the acid test ratio is low
Debtors could take too long to pay
Creditors are paid too soon
what is the reason if the acid test ratio is high
The business. Can settle short term debars without having to sell stick
what woud you recommend if the acid test ratio is low
?offer discounts to debtors for early payments ?
take the maximum time to pay creditors
What is the formula for average debtors collection period
Average debtors ~ credit sales x 365
How do y calculate average debtors
0,5( debtors opening balance + debtors closing balance )
What does this ratio show
It shows how many days debtors took to pay us
Determines whether the debtors are complying with the credit terms policy.
The ratios determines if there is an increase or weakening in credit control - how well are debtors being controlled?
How must this ration be compared to creators payment period
N.B.
The Debtors’ Collection Period must be shorter than the Creditors’ Payment Period.
What must we compare this ratio with
*Compare the result with the credit terms (e.g. 60 days)
*Compare result with the previous year.
What does it mean if this ratio. Is longer than the credit terms policy
*It could have a negative effect on the liquidity of the business if they take long to pay - it affects the available working capital (payment to creditors, salaries, rent, etc.)
• The credit term policy is not efficient
What does it mean if this ratio. Is complies than the credit terms policy
• The credit term policy is
efficient
It has a positive effect on the liquidity of the business
- cash is available to pay operating expenses
List some mentors to improve the collection period
- charge interest on overdue accounts
- offer discount for early payments
- no more sales to debtors with overdue amounts
-sent out monthly
statements
- regular follow-up telephonically, SMS
- strict credit control
- do not sell to problem debtors until they have settled acc
What is the formula for the average creditors payment period
Average Creditors x 365
Credit Purchases
What’s does this ration determine
whether there is compliance with the credit terms facilities arranged with creditors.
• Whether we are keeping with the internal payment policy of the business so that:
1) Settlement discounts are received.
2)Interest is not charged on overdue accounts.
3) Suppliers do not stop supplying due to late payment.
How long should we take to settle our acc
.
A longer payment period is better (60 - 90 days) to ensure cash flow to meet expenses.
What must we compare Thai ration to
- Compare with the credit terms policy
- Compare with the previous year
- Compare with the debtors’ collection period.
I just happened if debtirsvtake linger to pay account than we take to pay our creditors
, it may lead to cash flow problems.
What is recommended
RECOMMEND
Pay on time -
If accounts are settled on time, discounts can be obtained
Do not pay before the date -
rather invest the money to earn interest
Do not pay too late - to avoid paying interest.
Creditors won’t seek to us and our cash flow with not be enough and will decrease
List methods to improve payment period
:
Purchase
from suppliers that allow a payment period that suits the business needs
Be strict on stock levels
What is the formula for Rate of stock turnover
Cost of sales
Average inventories
=x times per year
Why is this calculated
This is calculated to determine the number of times stock is replaced per year - how fast stock is sold.
What should the answer be
The answer should be as high as possible, but will depend on the type of business. Food will have a higher turnover than cars.
This checks liquidity and operating efficiency.
What shoes we compare to
*Compare with previous year
*Compare with other
businesses that sell the same kind of product.
What does it mean if there is a fight stick turnover
A high stock turnover rate
Advantage to business
Sales increase - money
is quicker available
• Increase in sales leads to profits realized quicker
What does it mean if there is a low stock turnover
Low stock turnover rate
• Stock piling
(due to poor quality, aging, changes in fashion)
• Wrong purchase policy
• Poor sales policy
What are the consequences of stock piling
Decrease in profits due to storage costs
Liquidity is affected due to cash tied up in stock that cannot be sold easily.
What is recommend for rock turnover being low
• Look at purchase policy
• Look at sales policy
• Check stock levels - current assets should not consist of only stock.
What is the formula for stock holding period
Average inventories x 365
Cost of sales
Why’s is this calculated and what does it determine
It’s is calculated to help the business in planning to replace stock
(to place orders in time).
It determines how long it’s took to sell stock
Why’s should this ratio be
This must be as low as possible, but it depends on the type of business, time of the year, etc.
Clothing needs to change quarterly but perishable food has to be replaced daily or weekly.
What show this be compare to
Compare to previous year.
Why’s does it mean if the stock levels are low
Low stock levels means
• High turnover rate
Loss of stock due to
obsolescence can be eliminated
Loss due to price reductions can be eliminated
• Profits can be generated quickly
• No working capital is tied up in stock
What does it mean if stock levels are high
• Low turnover rate
Working capital is tied up in stock
• Loss of stock due to obsolescence and price reductions
What is recommended if stock levels are high
Better buying policy
• Strategy to increase sales
