Question

Can current liabilities be used as a way to manage earnings?

Please provide a resource if possible.

Answer 1

1. Current assets directly affect profitability as they include stock and it is the general rule that higher the stock level, higher the gross profit. Although current liability does not directly affects profitability but it do affects working capital of the firm. Working capital is positive when current assets exceed current liability. Positivie WC leads to lesser interest rates for working capital loans and thus increases profitability.

2. The cash conversion cycle (CCC) a calculation that measures how fast a company can convert cash on hand into inventory and accounts payable, through sales and accounts receivable, and then back into cash. Therefore, the CCC is calculated according to the cycle of cash through receivables, inventory, payables and, eventually, back to cash.
3. Cash Budgeted is construced by aniticipating all the cash inflows and cash outflows. Difference between inflows and outflows is considered as surplus or deficit in cash.

4. Working capital is the capital used for running of the business's daily activities. Lesser the working capital is involved better is the profitability. Higher WC indicates that business is not able to generate cash for its operations. With CCC and Cash Budget, company can manage its accounts recievables and accounts payables along with reducing cash expenses wherever possible.

5.a Cash can be determined by preparing cash accounts and physical counting of the same, difference should be reconcilled.

5.b Marketable securities is determined as per its carrying value.

5.c Accounts Recievable can be determined by calculating how much sales is made to a particular account and how much money has been recieved along with the opening balance dues, if any. This further can be substanitated by taking confirmation of accounts from the debtors that they too have same amount in their books as we have. Difference if any should be reconcilled.

5.d There can be many methods of determining inventory, i.e. Average costing, FIFO, LIFO. Company depending upon their needs and circumstances choose the method to be applied.

6. Credit policy is framed when company sales their products on credit terms. Typical credit policy consist of discount that can be availed if payments made within time period ofsay 10 days, 20 days etc. Company generally set their credit policies by determining the industry's credit policy and their own working capital requirements. Credit policy can increase sales as customers can avail cash discount on early payments as well as customers with no ready cash can purchase goods and pay later. It is like a win win situation for seller as well as buyer. However, having a lenghty credit terms can adversly affect profit as business will not be able to generate cash and have to avail working capital loans and pay interests on that, thus reducing profit. Moreover, they have to provide discounts on early profits which also reduces profit.

7. Credit rate and bank interest rate is determined on the basis of risk of return, inflation rate,duration, discount rates from federat bank etc.