Module 6 Flashcards
1
Q
The ability of a firm to meet its current obligations as they mature
A
Short-term liquidity
2
Q
The ability to convert assets into cash or to obtain cash
A
Liquidity
3
Q
Refers to one year or the normal operating cycle of the business, whichever is longer.
A
Short-term
4
Q
Refers to the efficiency with which a firm uses its current assets
A
Activity
5
Q
In evaluating liquidity, analysts are interested in information relating to these 3 things
A
1.amounts
2.timing
3.certainty of a company’s future cash flows
6
Q
Liquidity and certain areas of operating activity are dependent upon the :
A
working capital position of the firm
7
Q
It is the excess of current assets over current liabilities
A
Net working capital
8
Q
The amount of and changes in net working capital from period to period are :
A
significant measures of a company’s ability to pay its debts as they mature.
9
Q
Net working capital is generated to a great extent through events that occur during the :
A
1.operating cycle of a business, 2.transactions involving investing in inventories
3.converting inventories through sales to receivables
4.collecting the receivables
5.using the cash to pay current debts and to replace the inventory sold.
10
Q
Liquidity and activity ratios are useful in :
A
evaluating certain trends and relationships involving various aspects of the operating cycle of a business
11
Q
5 ratios of Liquidity Ratio
A
1.NET WORKING CAPITAL
2.CURRENT RATIO
3.QUICK (ACID-TEST) RATIO
4.CASH RATIO
5.CASH BURN RATE
12
Q
Formula for net working capital
A
Net working capital = Current assets - current liabilities
13
Q
These are assets that are expected to be converted into cash or used up within 1 year.
A
Current assets
14
Q
These are liabilities that must be paid within 1 year; they are paid out of current assets.
A
Current liabilities
15
Q
This is a safety cushion to creditors.
A
Net working capital
16
Q
This is required when the entity has difficulty borrowing on short notice.
A
A large balance is
17
Q
Formula for current ratio
A
Current ratio = Current assets / current liabilities
18
Q
This ratio expresses the relative relationship between current assets and current liabilities
A
The current ratio
19
Q
A very low current ratio would ordinarily cause for concern since :
A
cash flow problems appear imminent.
20
Q
An excessively high current ratio could suggest that the firm is :
A
not managing its current assets properly.
21
Q
Formula for quick ( acid test ) ratio
A
Quick( acid test ) ratio = Current assets - inventory - prepaid expense / current liabilities
OR
Quick( acid test ) ratio = cash + marketable securities + accounts receivable / current liabilities
22
Q
A quick measure of the debt-paying ability of a company is referred to as :
A
the quick ratio or acid-test ratio
23
Q
The quick ratio expresses the relationship of :
A
quick assets (cash, marketable securities, and accounts receivable) to current liabilities.
24
Q
Inventory and prepaid expenses are not considered quick assets because :
A
they may not be easily convertible into cash.
25
The acid-test ratio is a more severe test of a company's :
short-term ability to pay debt than is the current ratio
26
Two other popular liquidity ratios that a short-term creditor might be interested in are:
the cash ratio and the cash burn rate.
27
Formula for cash ratio
Cash ratio = cash / current liabilities
28
The cash ratio is also known as the :
Doomsday ratio
29
It is a more severe test of liquidity than the acid-test ratio.
Cash ratio or doomsday ratio
30
This ratio is most relevant for companies in financial distress.
Cash ratio or doomsday ratio
31
The doomsday ratio name comes from the worst-case assumption that the business :
ceases to exist and only the cash on hand is available to meet credit obligations.
32
Suppose that a company is facing a strike and cash inflows begin to dry up. This rate will indicate how long could the company keep running.
the cash burn rate:
33
Formula for cash burn rate
Cash burn rate = current assets / average daily operating expenses
34
The doomsday ratio name comes from the worst-case assumption that the business :
ceases to exist and only the cash on hand is available to meet credit obligations.
35
A company is facing a strike and cash inflows begin to dry up. This will indicate how long could the company keep running
cash burn rate
36
Formula for cash burn rate
Cash burn rate = Current assets / average daily operating expenses
37
4 ratios of Activity Ratio
1. Accounts receivable ratio
2. Bad debt ratio
3. Inventory ratio
4. Account payable ratio
38
This ratio are used to determine how quickly various accounts are converted into sales or cash.
Activity (asset utilization, turnover) ratios
39
Overall liquidity ratios generally do not give an adequate picture of a company's real liquidity, due to :
differences in the kinds of current assets and liabilities the company holds.
40
2 ratio of accounts receivable ratio
1. Accounts receivable turnover
2. Average collection period
41
This comprise the accounts receivable turnover and the average collection period.
ACCOUNTS RECEIVABLE RATIOS
42
The accounts receivable turnover gives the :
number of times accounts receivable is collected during the year.
43
Formula for accounts receivable turnover
Accounts receivable turnover = net credit sales ( total sales ) / average account receivable
44
Average accounts receivable is typically found by :
adding the beginning and ending accounts receivable and dividing by 2.
45
Although average accounts receivable may be computed :
1.annually
2.quarterly
3.monthly,
46
This ratio is most accurate when the shortest period available is used.
Account receivable turnover
47
In general, the higher the accounts receivable turnover :
the better since the company is collecting quickly from customers and these funds can then be invested.
48
However, an excessively high ratio of account receivable turnover may indicate that :
the company's credit policy is too stringent, with the company not tapping the potential for profit through sales to customers in higher risk classes.
49
This is the number of days it takes to collect on receivables.
The average collection period (the number of days' sales in receivables ratio)
50
Formula for average collection period
Average collection period = 365 days / accounts receivable turnover
51
Accounts receivable ratios are examined by short-term creditors as an :
indication of corporate liquidity.
52
A high turnover ratio and short collection period, indications that a company is able to :
collect quickly from customers and is looked upon favorably by creditors.
53
Bad debts ratios measure :
expected uncollectible on credit sales.
54
2 ratio of bad debt ratio
1. Bad debt to sale
2. Bad debts to account receivable
55
An increase in bad debts is a negative sign, since it indicates :
greater realization risk in accounts receivable and possible future write-offs.
56
Formula for bad debts to sales
Bad debts to sales = bad debts / sales
57
Formula for bad debts to accounts receivable
Bad debts to account receivable = bad debts / account receivable
58
They examine trends in bad-debt ratios.
Investment and credit analysts
59
This ratio establishes the relationship between the volume of goods sold and inventory.
The inventory turnover ratio
60
5 ratio of inventory ratio
1.inventory turnover
2.average age of inventory
3.finished goods inventory turnover
4.raw material inventory turnover
5.work-in-process inventory turnover
61
Formula for inventory turnover
Inventory turnover = cost of goods sold / average inventory
62
Average inventory is computed as follows:
beginning of period inventory plus end of period inventory divided by two.
63
When cost of goods sold is not available, some analysts use :
net sale in the numerator.
64
Formula for average age of inventory
Average age of inventory = 365 days / inventory turnover
65
This indicates the liquidity of the finished goods
The finished goods inventory turnover
66
Formula for finished goods turnover
Finished good inventory turnover = cost of goods sold / average finished goods inventory
67
This indicates the number of times raw material inventory was used on the average during the period.
raw material inventory turnover ratio
68
Formula for raw material turnover
Raw material inventory turnover = cost of goods sold / average raw material inventory
69
Formula for work-in-process inventory turnover
Work-in-process inventory turnover = cost of goods sold / average work in process inventory
70
2 ratio of account payable
1. Accounts payable turnover
2. Accounts payable period
71
The relationship of accounts payable to purchases of the period can provide information concerning the proportion of payables outstanding.
Accounts payable turnover
72
Formula for accounts payable turnover
Accounts payable turnover = cost of goods sold / average accounts payable
73
Formula for accounts payable period
Accounts payable period = 365 / accounts payable turnover
74
2 ratio of operation cycle of a business
1. Cash conversion cycle
2. Asset turnover
75
It is the time needed to turn cash into inventory, inventory into receivables, and receivables back into cash.
The operating cycle
76
The operating cycle is the time from the :
purchase of inventory to collection of cash.
77
Operating cycle of the firm
1. Cash
2. Purchase
3. Inventory
4. Sales
5. Accounts Receivable
=
Collection of receivable
78
Noncash working capital consists of :
current assets and liabilities, other than cash.
79
One way to view noncash working capital efficiency is to view operations as a cycle from :
initial purchase of inventory to the final collection upon sale.
80
The cycle begins with a :
purchase of inventory on account followed by the account payment, after which the item is sold and the account collected.
81
This is the number of days that pass before we collect the cash from a sale, measured from when we actually pay for the inventory.
Cash conversion cycle
82
Formula for cash conversion cycle
Cash conversion cycle = Operating cycle - accounts payable period
83
The operating cycle or cash conversion cycle is of interest to financial management because :
it reveals how long cash is tied up in inventory and receivables.
84
A shorter operating cycle is desired because :
the freed cash can be invested to add to the returns.
85
Short-term creditors are interested in knowing the cycle of a company since :
a shorter period indicates that cash will be more readily available to meet short-term obligations.
86
Suppliers and loan officers are more assured of repayment with :
a shorter cycle.
87
This ratio is helpful in evaluating a company's ability to use its asset base efficiently to generate revenue.
The total asset turnover ratio
88
2 ratio of asset turnover
1. Total asset turnover
2. Fixed asset turnover
89
Formula for total asset turnover
Total asset turnover = net sales / average total assets
90
Long-term investments are usually excluded from total assets when they :
make no contribution to sales.
91
This reflects the productivity and efficiency of property, plant, and equipment in generating revenue and earnings.
92
A high fixed-asset turnover reflects :
positively on the company's ability to utilize its fixed assets in business operations.
93
Formula for fixed asset turnover
Fixed asset turnover = sales / average fixed assets
94
Managers and financial analysts understand that assets should not be held by an enterprise unless :
they contribute to sales or profitability
95
Higher ratios of asset utilization are better because they indicate that :
assets are more productive in obtaining a return.
96
A trade-off exists between :
liquidity risk and return.
97
Liquidity risks are minimized by :
holding greater current assets than noncurrent assets.
98
The rate of return will decline because the return on current assets (i.e., marketable securities) is typically :
less than the rate earned on productive fixed assets.
99
Excessively high liquidity may mean that :
management has not aggressively searched for desirable capital investment opportunities.
100
Maintaining a proper balance between liquidity and return is :
important to the overall financial health of a business.
101
It must be pointed out that high profitability does not necessarily infer a
:
strong cash flow position.
102
Income may be high but cash problems may exist because of :
maturing debt and the need to replace assets
103
The impact of earning activities on liquidity is highlighted by :
comparing cash flow from operations to net income.
104
If accounts receivable and inventory turnover quickly, the cash flow received from customers can be invested for a return, thus :
increasing net income
105
5 Other ratio in Liquidity
1. Sales / number of calls
2. Travel expense / days
3. Selling expenses / sales
4. Sales / sales orders
5. Number of calls / days
106
Interpretation of sales / number of calls
Response per call
107
Interpretation of travel expense / days
Cost awareness
108
Interpretation of selling expenses / sales
Response per selling effort
109
Interpretation of sales / sales orders
Sales efficiency
110
Interpretation of number of calls / days
Sales effort
111
The liquidity and activity ratios provide information concerning the :
quality and liquidity of current assets, inventory, and receivables.
112
Inventory and receivables usually constitute a major portion of a firm's current assets and working capital and :
must receive special attention when analyzing financial statements
113
Creditors typically prefer companies with :
higher current and quick ratios and short operating cycles.
114
Excessively high ratios or short operating cycles could indicate :
unfavorable conditions.
115
Analysts should be aware that companies sometimes "manage' working capital and ratios just before
financial statements are presented by making working capital relationships look better than they actually are.
These practices commonly referred to as :
window dressing.
116
Also, many firms follow an acceptable practice of using a natural business year that ends when :
inventories and receivables are lowest.
117
Using the natural business year can make working capital and certain financial ratios :
more attractive than they might be if the companies were using another accounting period, such as a calendar year.
118
While the information derived from financial statement analysis can be extremely valuable, analysts should understand that financial statements have limitations and are compiled according to :
1.accounting assumptions
2.principles, procedures
3.policies.
