Week 14,15, & 16.docx

Outflows than can a firm without such credit line in

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outflows than can a firm without such credit line in reserve for use if cash stringencies develop. f. Inventory to Working Capital – working capital is defined as current assets minus current liabilities. This ratio is calculated by dividing the inventory figure by working capital. It shows the proportions of net current assets represented by the inventory component and it indicates the potential loss to the company from declines in inventory values. g. Receivables to Sales – Net receivables is divided into net credit sales which is of course, more closely related to accounts receivable than is total sales. Receivables include trade accounts receivable plus trade notes receivables. A lower ratio indicates a more rapid collection of sales during the period and greater liquidity of the receivables. h. Payables Turnover – Payable turnover is calculated by dividing the payables, either yearend or average of beginning and ending payables into total purchases for the periods and with terms of purchase common for the type of goods purchase. It brings to light tendencies toward slowing up or speeding up in payment. Leverage Ratios Leverage ratios measure the contribution of funding by owners compared with the financing provided by the creditors of the firm. If owners provided very small proportions of total financing, the risk of the enterprises are borne mainly by the creditors. By raising funds through debt, the owners gain the benefits of maintaining control of the firm with a limited investment. Moreover, if the firm earns more with the funds that it pays for the debt it has incurred, the return to the owners is magnified. a. Current Liabilities to Net Worth – The ratio of current liabilities to net worth measures the amount of funds raised by owners against the amount raised by current debt. A high ratio indicates that the firm is forced to resort to short-term, stop gap financing in the absence of long-term debt due to the owner’s unwillingness to put more funds into the business. b. Coverage of Fixed Charges – This is determined by dividing net profit by fixed interest and rental charges. Net Profit before income taxes should be used in the numerator because income taxes are applied after deducting fixed charges. This ratio measures the extent of the decline in earnings which could occur without resulting in
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financial embarrassment to the firm because of inability to meet annual fixed cash outlays. The inclusion of rent emphasizes the sale and leaseback financing schemes which some companies employ to improve its debt-to equity ratio. c. Debt-to-Equity Ratio – This measures the firm’s obligatios to creditors in relation to the funds provided by the owners. Debt includes current liabilities and bonds, whether in the form of mortgages, notes or debentures. Ownership funds are defined as preferred stock, common stock, capital surplus, retained earnings and any reserves which represents earmarked surplus. Creditors prefer that a debtor has a moderate
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