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Week 7 Notes.docx

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Wilfrid Laurier University
Laura Allan

Week 7 – February 25 – March 1 st Text: Unit 3 – Managing the Firm’s Finances, pages 196-228 Why evaluate financial performance?  Principle 1: Real human, and financial capital must be ‘rented’ from owners.  Principle 5: A venture’s financial objective is to increase value. Different analytical measures are important to different users at different stages… Financial Ratios Key ratio groupings:  Liquidity – ability to meet short term obligations  Conversion period – time to convert an asset into cash  Leverage – implications relating to the use of debt Analytical techniques  Industry comparable analysis – compare against average  Cross-sectional analysis – compare to specific firms  Trend analysis – compare over time Cash burn and build rates Cash Burn Rate  How quickly a venture ‘burns through’/uses cash  Determine weeks of cash remaining  Cash Burn = the cash a venture expends on its operating and financing expenses and its investments in assets  Cash Burn o = Cash Operating Expenses + Interest + Taxes o + increase in Inventories o – changes in Payables and Accruals o + Capital Expenditures  Cash Build Rate  How quickly a venture builds cash balances through collections on sales  Liquidity  The ability of the venture to maintain a build rate high enough to meet its obligations as they come due  Cash Build = what the venture receives on its sales  Cash Build  = Net Sales – Increase in Receivables  = Net Cash Burn – when cash burn exceeds cash build  Monthly Burn Rate o Monthly cash burn rate = o – Monthly cash build rate = o = Monthly net cash burn rate =  Burn and Build Rates can also be determined using the Cash Flow Statement  Cash flow from operating activities and investing activities Liquidity  Liquidity ratios measure ability to pay short-term debts  Creditors are interested so they know if you will pay them back  Current Ratio, Acid-test ratio, net-working capital ratio Current Ratio = average current assets / average current liabilities ** ‘rule of thumb’ >2, <4 Acid Test / Quick Ratio = average current assets – average inventories average current liabilities **‘rule of thumb’ >1 *** ACID TEST excludes inventory because it is the least liquid current asset NWC (net working capital) to Total Assets Ratio = average current assets – average current liabilities average total assets **the higher the percentage the greater the liquidity (measuring overall) Conversion Period Ratios: Measure the average time in days required for non-cash current assets and selected current liabilities to create or demand cash The faster assets can be converted into cash, the greater the liquidity (other things being equal) Operating Cycle: Measures the time it takes to purchase raw materials, assemble a product, book the sale, and collect on it Measuring Conversion Times Inventory-to-Sale Conversion Period = average inventory cost of goods sold/365 Sale-to-Cash Conversion Period: (days of sales outstanding or average collection period) = average receivables net sales/365 Inventory-to-Sale + Sale-to-Cash conversion period = Average Operating Cycle Purchase-to-
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