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BU121 Lecture Notes - Asset, Cash Flow Statement, Current Asset

Course Code
Laura Allan

of 5
Week 7 February 25th March 1st
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
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 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-Payment Conversion Period
= average payables + average accrued liabilities
cost of goods sold/365
Inventory-to-Sale + Sale-to-Cash
Purchase-to-Payment conversion period
= Cash Conversion Cycle (C3)
The number of days of operation that must be externally financed
Should be as close to 0 as possible
Considers how the firm acquired external financing (to support the longer C3)
Measures the extent to which the firm has used debt and its ability to meet its debt
What is the benefit of using debt vs equity?
*Interest vs. dividends
- debt financing has a lower overall cost because of the deductibility of interest expenses (for