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BU121 (464)
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Lecture

Liquidity.docx

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Department
Course Code
BU121
Professor
Laura Allan

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Bu121 Week 8 Lecture 1 Liquidity  Compares assets the can be quickly converted to cash with liabilities that represent near-term needs for cash  Addresses long-term trends  Evaluates working capital management issues  having sufficient current assets coming into pay current liabilities 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 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  Working capital = current assets – current liabilities 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  Risk/return should be in balance Measuring Conversion Times  Inventory-to-Sale Conversion period o how long it takes to convert inventories into sales o = average inventory/(cost of goods sold/365)  Sales-to-Cash Conversion Period o how long it takes to collect cash from the sale o days of sale outstanding or average collection period o = average receivables/ (net sales/365)  Inventory-to-sale + Sale-to-Cash conversion period o = Average Operating Cycle Measuring Conversion Times  Purchase-to-Payment Conversion Period o = (average payables + average accrued liabilities)/(cost of goods sold/365) o how long it takes on average to pay for purchases  Cash Conversion Cycle = Inventory-to-Sale + Sale-to-Cash - Purchase to payment conversion period o The number of days of operation that must be externally financed o Should be as close to 0 as possible Leverage  Consider how th
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