BUS 320 Study Guide - Final Guide: Current Liability, Accounts Payable, Asset Turnover

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Example3
3.1 Suppose a firm were to pay off some of its suppliers and short-term creditors. what
happens if a firm sells some merchandise?
The first case is a trick question. Suppose the firm has $4 in current assets and $2 in
current liabilities for a current ratio of 2. If we use $1 in cash to reduce current liabilities,
then the new current ratio is (4-1)/ (2-1) =3. If we reverse this to $2 in current assets and $4
in current liabilities, then the current ratio becomes (2-1)/ (4-1) =1/3
The second case, the current ratio would usually rise because inventory is normally shown
at cost and the sales would normally be at something greater than cost. The increase in
either cash or receivables is therefore greater than the decrease in inventory. This increases
current assets and the current ratio rises.
3.2 Payables turnover
Here is a variation on the receivables collection period. How long, on average, does it take
for Prufrock Corporation to pay its bills in 2009?
Account payable= cost of goods sold/ account payable= 1344/344= 3.9 times. So payables
turned over about every 365/344= 94 days. On average then, this company takes 94 days to
pay.
3.3 More turnovers
Suppose a company generates $0.4 in sales for every dollar in total assets. How often does
this company turn over its total asset?
The total asset turnover here is 0.4 times per year. It takes 1/0.4= 2.5 years to turn them
over completely.
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