Question

Black Sparrow Aviation, Inc. is concerned they are not maintaining adequate liquidity. The accounting department has provided you, the newly hired finance manager, with the following ratios:

Current ratio 4.5 Industry norm 4.0

Quick ratio 2.0 Industry norm 3.1

Inventory turnover 6.0 Industry norm 10.4

Average collection period 73 days Industry norm 52 days

Average payment period 31 days Industry norm 40 days

In your opinion, what do these ratios indicate about Black Sparrow Aviation, Inc.?

What recommendations would you make based on these ratios? What results do you think you can achieve if your recommendations are followed? Why might your recommendations not be effective?

Answer 1

The Current ratio that ratio of current assets and current liabilities is more in Black Sparrow Aviation as compared to Industry. So the liquidity is higher.
Quick ratio is less which indicates that the average inventories of the company is higher than average which is reducing the inventory less current assets. This indicates the company cash is parked in high levels of inventory.

Less inventory turnover indicates that the operational efficiency of the company is less and it is unable to convert its inventories to sales. Higher inventories increase carrying and holding costs.
Average collection period is higher and average payment period is less indicating that the company always has less cash as compared to the industry indicating a cash crunch for the company.

My recommendations would be discuss with creditors and debtors for favourable terms of credit. The collection period should be reduced by offering trade discounts or other benefits. The Average payment period should be increased by discussing with creditors for favourable terms.

he above recommendation will fail due to competition. The favourable collection period is attracting customers to the firm. If the collection period is decreases there is chance of loss of revenue as customers might decrease or they might decrease the order.
If payment days are increased creditors might not lend cash in future. Funding will be a issue and also supplier might not supply resulting in back orders or loss in opportunity.