Current ratio Current assets Current liabilities 2004 2003 26400 13160

Current ratio current assets current liabilities 2004

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Current ratio = Current assets / Current liabilities 2004 2003 26400 /13,160 15600/6400 = 2: 1 = 2.4: 1 Observation The enterprise appears to nave a strong liquidity position. There has been, however, a slight drop from year 2003 to year 2004. For every shilling that is owed in 2004, the firm has Sh.2 to pay the debt and for every shilling owed in 2003 , the firm has Sh.2.40 available to meet the liability. If the firm’s current ratio is divided into 1.0 and the resulting value is subtracted from 1.0, the difference when multiplied by 100 represents the
FINANCIAL MANAGEMENT 28 percent by which the firm’s current assets can shrink without making it impossible for the firm to cover its current liabilities. A current ratio of 2 means that the firm can still cover its current liabilities even if its current assets shrink by 50 percent ([1.0 – (1.0/2.0)]× 100). b) Quick/acid test ratio = current assets- stock Current liabilities It is a more refined ratio than the current ratio in which the stocks are excluded as they may not be easily converted to cash. the ratio indicates the firms ability to pay the current liabilities from the more liquid assets of the firm. c) Cash ratio = cash + short term marketable securities Current liabilities This is a refinement of the quick ratio indicating the ability of the firm to meet its current liabilities from its most liquid resources. Short term marketable securities include commercial paper and treasury bills and other short term investments. 2. Turnover ratios They are also known as efficiency or activity ratios . They indicate the efficiency with which the firm has utilized the assets or resources to generate sales revenue/turnover. Activity ratios can be categorized into two groups: The first group measures the activity of the most important current accounts, which include inventory, accounts receivable, and accounts payable 1 . The second group measures the efficiency of utilization of total assets and fixed assets. a) Stock/inventory turnover = cost of sales Average stock It indicates the number of times the stock was turned into sales in the year. The higher the ratio, the better the firm and the higher the sales. A low stock turnover ratio indicates that the stock levels are either very high or they are slow moving this leads to a reduction in the firms profitability. Note: the average stock is the average of the opening and closing stock. 1
FINANCIAL MANAGEMENT 29 b) Stock holding period = 360 Days x average stock Cost of sales Indicates the number of days the stock was held in the warehouse before being sold. c) Debtors turnover = Annual credit sales Average debtor This ratio indicates the number of times debtors come to buy on credit after paying their dues to the firm. If the rate is high the better the firm as it means they bought many times hence meaning they paid within a shorter time. The average debtor is the average of the opening and closing debtor balances. If no opening debtors are given use the closing debtors to represent average debtors.

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• Spring '16
• professor Rachael

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