of 22
7/23/2019 Lecture 6 Chapter10
1/22
10-1
10CHAPTER
Credit Analysis
7/23/2019 Lecture 6 Chapter10
2/22
10-2
Liquidity and Working Capital
Liquidity -Ability to convert assets into cash or to obtaincash to meet short-term obligations. Short-term - Conventionally viewed as a period up to
one year. Working Capital - The excess o current assets over
current liabilities.
Liquidity -Ability to convert assets into cash or to obtaincash to meet short-term obligations.
Short-term - Conventionally viewed as a period up toone year.
Working Capital - The excess o current assets overcurrent liabilities.
Basics
7/23/2019 Lecture 6 Chapter10
3/22
10-!
Liquidity and Working Capital
" Current Assets- Cash and other assets reasonably expected tobe #1$ reali%ed in cash& or #2$ sold or consumed& during the longero one-year or the operating cycle.
" Current liabilities- 'bligations to be satisied within a relativelyshort period& usually a year.
" Working Capital- (xcess o current assets over current liabilities
) *idely used measure o short-term li+uidity
) Constraint or technical deault in many debt agreements
" Current Ratio) ,atio o Current Assets to Current iabilities
) ,elevant measure o current liability coverage& buer against losses&reserve o li+uid unds.
) imitations ) A static measure
Basics
7/23/2019 Lecture 6 Chapter10
4/22
10-
Liquidity and Working Capital
" /umerator Considerations) Adustments needed to counter limitations such as
" ailure to relect open lines o credit
" Adust securities3 valuation since the balance sheet date
" ,elect revolving nature o accounts receivable
" ,ecogni%e proit margin in inventory
" Adust inventory values to mar4et
" ,emove deerred charges o dubious li+uidity rom prepaidexpenses
" 5enominator Considerations) 6ayables vary with sales.
) Current liabilities do not include prospective cash outlays.
Current Ratio
7/23/2019 Lecture 6 Chapter10
5/22
10-7
Liquidity and Working Capital
" i+uidity depends to a large extent on prospective cashlows and to a lesser extent on the level o cash and
cash e+uivalents." /o direct relation between balances o wor4ing capital
accounts and li4ely patterns o uture cash lows." 8anagerial policies regarding receivables and
inventories are directed primarily at eicient and
proitable asset utili%ation and secondarily at li+uidity.
" Two elements integral to the use o current ratio) 9uality o both current assets and current liabilities.) Turnover rate o both current assets and current liabilities.
Current Ratio
7/23/2019 Lecture 6 Chapter10
6/22
10-:
Liquidity and Working Capital
" Comparative Analysis) Trend analysis
" ,atio 8anagement #window dressing$
) Toward close o a period& management will occasionally press thecollection o receivables& reduce inventory below normal levels& anddelay normal purchases.
" ,ule o Thumb Analysis #21$) Current ratio above 21 - superior coverage o current liabilities #but not
too high - ineicient resource use and reduced returns$
) Current ratio below 21 - deicient coverage o current liabilities" /ote o caution) 9uality o current assets and the composition o current liabilities are
more important in evaluating the current ratio.) *or4ing capital re+uirements vary with industry conditions and the
length o a company3s net trade cycle.
Current Ratio - Applications
7/23/2019 Lecture 6 Chapter10
7/22
10-;
Liquidity and Working Capital
" /et Trade Cycle Analysis
Current Ratio - Applications
7/23/2019 Lecture 6 Chapter10
8/22
10-
