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14 Presentation of published financial statements (2)
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- Efficiency ratios: control of receivables and inventories
- Formula to learn The figure for sales should be taken as the sales revenue figure in the statement of profit or loss. Note that any cash sales should be excluded
- Accounts receivable collection period: examples
- Inventory turnover period
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Current ratio =
Current liabilities Formula to learn The idea behind this is that a company should have enough current assets that give a promise of 'cash to come' to meet its future commitments to pay off its current liabilities. Obviously, a ratio in excess of 1 should be expected. Otherwise, there would be the prospect that the company might be unable to pay its debts on time. In practice, a ratio comfortably in excess of 1 should be expected, but what is 'comfortable varies between different types of businesses. BPP LEARNING MEDIA Companies are not able to convert all their current assets into cash very quickly. In particular, some manufacturing companies might hold large quantities of raw material inventories, which must be used in production to create finished goods inventory. These might be warehoused for a long time, or sold on lengthy credit. In such businesses, where inventory turnover is slow, most inventories are not very 'liquid' assets, because the cash cycle is so long. For these reasons, we calculate an additional liquidity ratio, known as the quick ratio or acid test ratio. The quick ratio, or acid test ratio, is calculated as follows. _ . , x. Current assets less inventory Quick ratio = - - Current liabilities Formula to learn This ratio should ideally be at least 1 for companies with a slow inventory turnover. For companies with a fast inventory turnover, a quick ratio can be comfortably less than 1 without suggesting that the company could be in cash flow trouble. Both the current ratio and the quick ratio offer an indication of the company's liquidity position, but the absolute figures should not be interpreted too literally. It is often theorised that an acceptable current ratio is 1.5 and an acceptable quick ratio is 0.8, but these should only be used as a guide. Different businesses operate in very different ways. A supermarket group for example might have a current ratio of 0.52 and a quick ratio of 0.17. Supermarkets have low receivables (people do not buy groceries on credit), low cash (good cash management), medium inventories (high inventories but quick turnover, particularly in view of perishability) and very high payables. Contrast this with, for example, a luxury sofa manufacturer is likely to have a higher current ratio (to cover the time to make the sofas as well as holding sufficient materials on hand). Compare this with a manufacturing and retail organisation, with a current ratio of 1.44 and a quick ratio of 1.03. Such businesses operate with liquidity ratios closer to the standard. What is important is the trend of these ratios. From this, one can easily ascertain whether liquidity is improving or deteriorating. If a supermarket has traded for the last ten years (very successfully) with current ratios of 0.52 and quick ratios of 0., then it should be supposed that the company can continue in business with those levels of liquidity. If in the following year the current ratio were to fall to 0.38 and the quick ratio to 0.09, then further investigation into the liquidity situation would be appropriate. It is the relative position that is far more important than the absolute figures. Don't forget the other side of the coin either. A current ratio and a quick ratio can get bigger than they need to be. A company that has large volumes of inventories and receivables might be over-investing in working capital, and so tying up more funds in the business than it needs to. This would suggest poor management of receivables (credit) or inventories by the company. Efficiency ratios: control of receivables and inventories A rough measure of the average length of time it takes for a company’s customers to pay what they owe is the accounts receivable collection period. The estimated average accounts receivable collection period is calculated as: Trade receivables x 365 days Sales Formula to learn The figure for sales should be taken as the sales revenue figure in the statement of profit or loss. Note that any cash sales should be excluded - this ratio only uses credit sales. The trade receivables are not the total figure for receivables in the statement of financial position, which includes prepayments and non-trade receivables. The trade receivables figure will be itemised in an analysis of the receivable total, in a note to the accounts. The estimate of the accounts receivable collection period is only approximate. (a) The value of receivables in the statement of financial position might be abnormally high or low compared with the 'normal' level the company usually has. Sales revenue in the statement of profit or loss is exclusive of sales taxes, but receivables in the statement of financial position are inclusive of sales tax. We are not strictly comparing like with like. Sales are usually made on 'normal credit terms' of payment within 30 days. A collection period significantly in excess of this might be representative of poor management of funds of a business. However, some companies must allow generous credit terms to win customers. Exporting companies in particular may have to carry large amounts of receivables, and so their average collection period might be well in excess of 30 days. The type of company is also important: A retail company will have the majority of its sales made with immediate payment (such as shops, online sales where the customer pays prior the goods being despatched). A wholesaler or distribution company is more likely to offer credit terms, so for example, a wholesaler will sell its range of toys to a retail store offering 30-60 day credit terms. It is important to give reasons specific to the example in the exam, as noting a company with few trade receivables may be implicit of the type of company rather than them being particularly good at credit collection. The trend of the collection period over time is probably the best guide. If the collection period is increasing year on year, this is indicative of a poorly managed credit control function (and potentially therefore a poorly managed company). Also, this may affect credit being offered to it in the longer term, which would mean paying for its supplies up front (or proforma') which would put an increased pressure on the cash flow. Accounts receivable collection period: examples Using the same types of company as examples, the collection period for each of the companies was as follows.
The differences in collection period reflect the differences between the types of business. Supermarkets have hardly any trade receivables at all, whereas the manufacturing companies have far more. The collection periods are fairly constant from the previous year for all three companies. Inventory turnover period Download 0.93 Mb. Do'stlaringiz bilan baham: 
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