Question

In: Finance

Use the following information to calculate these various solvency measures:    a) NWC, B) WCR, c) Current...

Use the following information to calculate these various solvency measures:    a) NWC,

B) WCR,

c) Current ratio,

d) Quick ratio

e) Cash Conversion Efficiency (CCE)

d) Days cash held (DCH)

Cash $150000
Current asset $900,000
Current liability $700,000
Inventory $350,000
Receivable $250,000
Payable $300,000
Sales 1,800, 000
COGs =40% of sales
Cash flow from operation 130, 000

Solutions

Expert Solution

Solution:

  1. Net working capital is the amount of funds that are available for short term operations of business. Positive value broadly indicates that business is able to pay off current liabilities using current assets in the short term.

Formula:

Net Working Capital = Current Assets – Current Liabilities

= $900,000 - $700,000

= $200,000 (Answer Part A)

  1. WCR or Working Capital Ratio is a liquidity ratio that measures capacity of business to pay off its current liabilities.

Formula:

WCR (Working Capital Ratio) = Current Assets / Current Liabilities

= $900,000 / $700,000

= 1.2857 or 1.29 times (Answer Part B)

  1. Working capital ratio is also known as current ratio. Hence, output will be same.

Formula:

Current Ratio = Current Assets / Current Liabilities

= $900,000 / $700,000

= 1.2857 or 1.29 times (Answer Part C)

  1. Also known as acid test ratio, quick ratio measures ability to pay short term liabilities by a business from current assets that are readily convertible to cash. Inventory and prepaid expenses are thus excluded from total current assets. In another approach, cash and cash equivalents, accounts receivables and marketable securities are considered in calculation. Output are same when compete information is there. Here, information like prepaid expenses, marketable securities, etc. are not provided.

Formula:

Quick Ratio = (Current Assets – Prepaid Expenses – Inventory) / Current Liability

= ($900,000 – $350,000) / $700,000

= $550,000 / $700,000

= 0.7857 or 0.79 times (Answer Part D)

Alternative formula:

Quick Ratio = (Cash and cash equivalents + Marketable securities + Accounts receivable) / Current Liability

= ($150,000 + $250,000) / $700,000

= 0.5714 or 0.57 times (Alternative answer Part D)

  1. This is an efficiency ratio which tells the no. of days that cash is tied up in inventory and receivables of a business.

Formula:

Cash Conversion Efficiency or Cash Conversion Cycle = DSO + DIO – DPO

Where,

DSO (Days sales outstanding) = Average Accounts Receivable x 365 / Credit Sales

= $250,000 x 365 / $1,800,000

= 50.69 days

DIO (Days inventory outstanding) = Average Inventories x 365 / Cost of Goods Sold

= $350,000 x 365 / ($1,800,000 x 40%)

= $350,000 x 365 / $720,000

= 177.43 days

DPO (Days payable outstanding) = Average Accounts Payable x 365 / Cost of Goods Sold

= $300,000 x 365 / $720,000

= 152.08 days

Hence, Cash Conversion Cycle = 50.69 + 177.43 – 152.08

= 76.04 days (Answer Part E)

  1. This ratio estimates the no. of days that a business can continue to bear its operating expenses from the given amount of available cash assuming there may be no sales or additional cash generated.

Here, operating expense is not given and only operating cash flow is given which is also positive. Hence, it is assumed that COGS of sales made is operating expense of business less cooperating cash made i.e. $720,000 - $130,000 = $590,000. It is to be noted that information is not complete.

Formula:

Days cash held = (Cash in hand / (Operating Expenses – Non cash expenses)) x 365

= ($150,000 / $590,000) x 365

= 92.79 days (Answer Part F)


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