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Unformatted text preview: 126 Chapter 6 Liquidity of Short-term Assets: Related Debt-Paying Ability QUESTIONS 6- 1. In the very short run, the procedure of making more funds available by slowing the rate of payments on accounts payable would work and the firm would have more funds to purchase inventory, which would in turn enable the firm to generate more sales. This procedure would not work very long because creditors would demand payment and they may refuse to sell to our firm or demand cash upon delivery. In either case, the end result would be the opposite of what was intended. 6- 2. When a firm is growing fast, it needs a large amount of funds to expand its inventory and receivables. At the same time, payroll and payables require funds. Although Jones Wholesale Company has maintained an above average current ratio for the wholesale industry, it has probably built up inventory and receivables, which require funds. The inventory and the receivables are probably being carried for longer periods of time than the credit terms received on the payables. Funds may have also been applied from current operations towards long-term assets in order to expand capacity. Fast-growing firms typically do have a problem with a shortage of funds. It is important that they minimize this problem in order to avoid a bad credit rating and possible bankruptcy. 6- 3. Current assets are assets that are in the form of cash or that will be realized in cash or that conserve the use of cash within an operating cycle of a business, or one year, whichever is the longer period of time. The other assets are not expected to be realized in cash in the near future and should, therefore, be segregated from current assets. 6- 4. The operating cycle is the period of time elapsing between the acquisition of goods and the final cash realization resulting from sales and subsequent collections. 6- 5. Current assets are assets that are in the form of cash or that will be realized in cash or that conserve the use of cash within the operating cycle of a business, or one year, whichever is the longer period of time. 6- 6. The five major categories of items that are found in current assets are the following: a. cash d. inventories 127 b. marketable securities e. prepaids c. receivables 6- 7. The cash frozen in a bank in Cuba should not be classified as a current asset because it is not readily available to be used in operations. 6- 8. This guaranteed note would not be recorded by A.B. Smith Company; therefore, it would not influence the liquidity ratios. The potential impact on the liquidity of A.B. Smith Company should be considered because A.B. Smith Company could be called upon to pay the note. The guarantee would be disclosed in a note....
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