The total of current assets is called “Gross Working Capital” in financial statement analysis.
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How do we call the current assets in financial statement analysis?
Why the gross working capital is important in financial statement analysis?
Gross working capital enables the business to make cash purchases, cash payments for expenses, production and sales activities and to pay short term debts.
What is the difference between current assets and current liabilities called?
The excess of current assets over current liabilities is called “Net Working Capital”; if the total amount of current assets is less than the amount of current liabilities, the difference is called “Net Working Capital Deficit”.
What are the consequences of a net working capital deficit in the business?
If the business has a net working capital deficit, it will have certain difficulties in paying its short term liabilities and continue its operations.
When determining the ability to pay short-term debts using comparative financial statement analysis (horizontal analysis), changes in which items are examined?
When determining the ability to pay short term debts by using comparative financial statement analysis
(horizontal analysis), changes in the items of current assets and current liabilities are examined.
If there is a sharp decrease in current assets while there is a sharp increase in short-term liabilities, how will the solvency of short-term liabilities be affected?
For example, if there is a tendency of sharp decrease in current assets but a sharp increase in current liabilities, the ability to pay its short term liabilities will be significantly weakened.
How are the vertical percentages of current assets and short-term liabilities calculated when analyzing short-term solvency with the vertical analysis method?
As mentioned before, in making vertical analysis, current assets and current liabilities and also each
item is divided by the total amount of assets and the composition of these percentages are examined.
In vertical analysis for analyzing the ability to pay short term liabilities, the percentages of current assets and current liabilities are compared to each other.
Why should vertical percentages of inventories not be too high when the percentages of each item are calculated to examine the distribution of items in current assets?
For examining the distribution of the items in current assets, the percentages of inventories should not be so high since they cannot be easily turned into cash. For inventories it is also important to keep sufficient levels of inventories.
What are cash and assets that are expected to be collected, sold, used and consumed within one year from the balance sheet date?
Current assets are cash and those assets that are expected to be collected, sold, used, consumed
within one year, starting from the balance sheet date.
What are the liabilities that are expected to be paid or settled within one year from the balance sheet date?
Current liabilities are those obligations that are expected to be paid or settled within one year, starting from the balance sheet date.
Which type of ratios help to analyze the extent to which current assets can meet short-term liabilities?
Liquidity ratios help in analyzing to which degree the current assets are able to meet short term liabilities.
What are the most common liquidity ratios?
The most common liquidity ratios are as follows:
• Current Ratio
• Quick ratio (also called liquidity ratio or acid-test ratio)
• Cash Ratio
• Inventory Dependency Ratio
What is the formula for the current ratio?
Current Ratio = Current Assets / Current Liabilities
What can we say about the short-term debt paying ability of a business if the current ratio is less than 1?
Low values for the current ratio (less than 1) may indicate that a firm may have difficulty meeting
current obligations.
Which current asset item is not included in the calculation of the quick ratio?
The most basic definition of quick ratio is that it compares the current debts to the liquid assets,
marketable securities and receivables. It is computed as;
Quick Ratio= Liquid Assets+MarketableSecurities+Receivables / Current Liabilities
Inventory is not included in the calculation of the asset-test ratio as it can be quite difficult for a
business to convert all its inventory into cash within a short period of time. The exclusion of inventory
from the formula makes the quick ratio a better indicator of a company’s ability to pay-off its current
obligations than the current ratio which does include inventory in its formula.
Which ratio shows the ability of the business to pay its short-term liabilities using only its liquid assets (cash and cash equivalents) and very liquid short-term investments?
Cash ratio indicates the business’s ability to pay its short term liabilities by using only its
liquid assets (cash and cash equivalents) and very liquid short term investments.
What is the result of current ratio if the total amount of current assets 300,000 TL and total amount of total current liabilities 150,000 TL?
The current ratio of this business is computed as follows;
the total amount of current assets 300,000 TL is divided by the total amount of total current liabilities 150,000 TL, which is equal to 2.00.
Liquidity ratios are very useful in the analysis of short-term solvency, but due to the static nature of these ratios, they are sometimes not sufficient to understand the short term debt paying ability of the business. What information is also needed to analyze short-term debt paying ability more dynamically?
The liquidity of a business is measured by liquidity ratios; they are very useful in examining the ability to pay short term debts. However, these ratios are static, and sometimes may not be sufficient to understand this ability. Therefore, a more dynamic measure is required, which is the cash conversion cycle. It is widely accepted that the cash conversion cycle (CCC) is very important in working capital management.
How can we calculate the cash conversion cycle (CCC)?
The cash conversion cycle (CCC) is computed as follows; “days inventory outstanding” (DIO) plus
“days sales outstanding” (DSO) minus “days payable outstanding” (DPO). The CCC is equal to the
operating cycle minus days payable outstanding.
The CCC is equal to the time is takes to sell inventory and collect receivables less the time it takes to pay the company’s payables;
Cash Conversion Cycle (CCC) = DIO + DSO – DPO
If the "day’s inventory outstanding" is 60 days, “Receivable Turnover” is 12, and the "cash conversion cycle" is 28 days, what is “days payable outstanding”?
The cash conversion cycle (CCC) is computed as follows;
“days inventory outstanding” (DIO) plus “days sales outstanding” (DSO) minus “days payable outstanding” (DPO).
Cash Conversion Cycle (CCC) = DIO + DSO – DPO
28 = (60+ 30) – DPO
DPO = 62 Days
Once receivable turnover is known, days sales outstanding (DSO) can be calculated;
DSO = 365 / Receivable Turnover
DSO = 365 / 12 = 30 days