MAA103 Lecture Notes - Lecture 10: Overdraft, Business Cycle, Debt Service Coverage Ratio

• School: Deakin University
• Department: Business and Law
• Course: MAA103
• Professor: All

Document Summary

Topic 10 - analysis and interpretation of financial statements - part 2. The survival of the entity depends on its ability to pay its debts when they fall due (its liquidity) An entity must have sufficient working capital to satisfy its short-term requirements and obligations. But excess working capital is undesirable because the funds could be invested in other assets that would generate higher returns. Current ratio (or working capital ratio) indicates $ of current assets per $ of current liabilities. Measures the ability of the firm to meet its short-term debt obligations. An arbitrary rule of thumb ratio of 1. 5:1 (that is, . 50 of current assets for every of current liabilities) is considered a minimum, however it varies across different industries. A low current ratio may indicate an inability to meet short term debts in an emergency. A high current ratio is not necessarily good as it could be due to excess investments in unprofitable current assets.