Likewise higher inventory turnover and the associated

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Likewise, higher Inventory Turnover (and the associated lower inventory balances) will decrease the current ratio. Thus, the current ratio can be lower for a good reason; the firm is managing their inventory well. The quick ratio overcomes this interpretation problem with the current ratio. Quick Ratio = Cash + Marketable Securities + Accounts Receivable Current Liabilities The higher the ratio, the greater the liquidity. 5
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Riffe – ACCT 6201 – Session 7 – Fall 2018 Balance sheet accounts are listed in the order of liquidity. The assets in the numerator of the quick ratio are the 3 most liquid assets (listed first on the balance sheet) that turn into cash very quickly. The numerator excludes inventory and other current assets that take longer to turn into cash. 6
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Riffe – ACCT 6201 – Session 7 – Fall 2018 Accounts payable turnover = CGS Average Accounts Payable A higher ratio indicates that the firm pays their suppliers faster. It measures the number of times average payable balance is built up and paid off during the year. Interpret accounts payable turnover carefully. 1. High turnover can mean either the ability to pay off suppliers quickly to take advantage of discounts offered by suppliers for prompt payment (which is good) OR that the suppliers demand to be paid quickly because of the firm’s lack of negotiating power (which is bad). 2. Low turnover can mean either trouble paying suppliers if there is evidence of liquidity problems elsewhere on the statements (which is bad) OR effective use of a low cost source of financing if there is no evidence of liquidity problems elsewhere on the statements (which is good). 365/Accounts Payable Turnover = Average number of days that accounts payable is outstanding. Cash Conversion Cycle – MOST IMPORTANT + Days Inventory Held + Days Accounts Receivable Outstanding – Days Accounts Payable Outstanding = Cash Conversion Cycle The average days inventory is held plus the average days accounts receivable is outstanding measures the time it takes a firm to turn inventory into cash. The average days accounts payable are outstanding is an interest-free source of financing as the firm waits for cash to come in. The net of the three amounts shows the number of days a firm has to finance operations with cash reserves, additional borrowing or additional equity as it waits for the cash to come in from inventory sales. Decreasing the Cash Conversion Cycle increases liquidity, decreases risk and reduces the need for other sources of financing. Calculation for TI in 2017 + Days Inventory Held +127.89 + Days Accounts Receivable Outstanding +31.045 – Days Accounts Payable Outstanding - 29.421 = Cash Conversion Cycle = 129.514 Average Days Inv. Held (365/Inv. Turn) Average Days AR Outstanding (365/AR Turn) 127.890 31.045 Average Days AP Outstanding (365/AP Turn) Cash Conversion Cycle 29.421 129.514 7
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Riffe – ACCT 6201 – Session 7 – Fall 2018 8
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Riffe – ACCT 6201 – Session 7 – Fall 2018 How can TI decrease the Cash Conversion Cycle and what are the downsides of making those changes? 1. Decrease the no. days held or sell inventory faster 2. Pay late to your supplies or increase the no. of days payable outstanding or pay slow to suppiers 3. Collect accounts receivable faster Trend Analysis 2016 to 2017 Current ratio went up, more liquidity and less risk, they are more current assets available to pay their current liabilities, more net working capital Quick ratio went up, more liquidity less risk and it is good. More quick assets, very liquid assets to pay
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  • Fall '09
  • Robbins
  • Balance Sheet, Generally Accepted Accounting Principles, TI

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