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Lecture

# BU121 Lecture Notes - Asset, Current Liability, Finished Good

Department
Course Code
BU121
Professor
Roopa Reddy

Page:
of 4
LIQUIDITY:
- How easily you can turn assets to cash
- Looking to address long term trends
- Evaluates “working capital management” issues
Current Ratio
Add the 2 and divide by 2 to make it an average
- Bench mark: Should be greater than 2 but less than 4
- You will lose out on return potential you could use the extra cash to create more return (you
don’t want to hold too much cash)
- = average current assets / average current liabilities
Acid Test / Quick Ratio
- Removing inventory (something that isn’t very liquid)
- Bench mark: Greater than 1
- = Average Current Assets Average Inventories
Average Current Liabilities
NWC (Networking Capital) to total Assets
- The higher the better
- Average current assets average current liabilities
Average total assets
Interpreting Trends
- Looking at how fast your company burns cash compared to how much cash they build
- Looking at current ratio and quick ration when there is a large difference than there is a lot of
liquidity held in inventory
- They could improve their liquidity by:
o Cutting back spending
o How you are paying
o How you are collecting accounts receivables
Conversion Period Ratios
- Measure the average time in days required for non-cash current assets and selected current
liabilities to create or demand cash
Operating cycle
- Measure time it takes to:
o purchase raw material
o build the product
o book the sale
o collect the money from the sale
- you don’t want to tie up to much money in inventory
Measuring conversion times
- inventory to sale conversion period
- =average inventory
Cost of goods sold / 365
- Sale to cash conversion 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
Cash
Materials
Work-in-
progress
Finished Goods
Receivables
(credit sales)
- Some cash has to go buying products some has to go towards paying payables and accrued
liabilities
- Inventory to sale + sale to cash purchase to payment conversion period = Cash Conversion
Cycle (C3)
- The number of sales of operations that must be externally financed (looking for money to cover
the gap of the day that are not covered)
- You want this number as close to 0 as possible
Taking longer to sell inventory (increase)
- Maybe you are holding too much inventory increase in inventory
- Sales decreased (seasonal, economic trend (change in consumer taste, etc., new competitors,
slowdown in the economy, etc.)
If you are paying your payables quickly it burns out your cash
Relates to Net Cash Burn
- Spending quicker than you are bringing in
LEVERAGE
- For the company as a whole
- How much debt you are taking on
- Borrowing money inorder to try to make more money off of it Risky
- How much debt are they using to meet their obligations
- Consider: debt vs. equity? Why is it better to use debt?
o Interest vs. dividends
o Debt you are legally obligated to pay more interest when you pay on more debt
o Equity giving up a piece of ownerships of a company let risky b/c dividends are
optional
o When there is high risk there is higher return
o Control vs. legal recourse
You don’t lose control through financing with debt – with equity you lose
control and part of your company
Debt they don’t care where the money goes – but there is a legal obligation to
repay the money ( if you don’t repay the people who give you a loan have the
right to take legal steps to get their money back )
Debt is risker has a lower cost of capital
- Debt you deduct the interest before you pay taxes (save on taxes)