Learning area 9 Chapter 12 Lecture 3(b). 8 Liquidity ratios page 38 …NB Measure if a company can...

Learning area 9

Chapter 12 Lecture 3(b)

8 Liquidity ratios page 38 …NB

• Measure if a company can pay its short-term debts when they become due

8.1 Current ratio:= current assets

current liabilities• Does the company have sufficient current assets to

pay its current liabilities?• Norm: 2:1 (may differ for different industries)• Too low? (struggle to pay creditors)• Too high? (too much money in unproductive s/t

assets)• Only read p39

8 Liquidity ratios page 40 (continue…)

8.2 Quick ratio (acid test/liquidity ratio):= current assets – inventories (stocks)

current liabilities• If inventories are not sold, will the company still

be able to pay its current liabilities?• Norm: 1:1• Ratio of less than 1 – indication company might

struggle to pay its creditors

8 Liquidity ratios Cover-up Ltd:• Current ratio:

= 116 000/41 000= 2.83

• Quick ratio:= (116 000 – 42 000)/41 000 = 1.8

OR = (60 000 + 14 000)/41 000 = 1.8

9 Efficiency ratios page 41

• How efficiently is the company’s working capital (stock, debtors, creditors) managed?

9.1 Stock turnover9.2 Debtors turnover period9.3 Creditors turnover period

9.1 Stock (inventory) turnover period page 41

= stock x 365Cost of sales

• How long is stock held before it is sold?• Stocks = raw materials + work-in-progress +

finished goods• Compare to similar industry!• Cover-up Ltd:

= 42 000/132 000 x 365= 116 days

9.2 Debtors turnover period page 42

= debtors (trade receivables) x 365 credit sales

• Average time that debtors take to settle their balances

• Credit sales – only portion sold on credit!!• Cover-up Ltd (assume 80% of sales on credit):

= 60 000/(250 000 x 80%) x 365= 109.5 days

9.3 Creditors turnover ratio page 43

= trade payables (creditors) x 365credit purchases

• Average time that a company takes to pay its creditors

• Cover-up Ltd (assume purchases 100% on credit)

= 32 000/95 000 x 365= 123 days

9 Efficiency ratios• Cash conversion cycle: = Stock turnover + debtors turnover period –

creditors turnover period• Cover-up Ltd= 116 + 110 – 123= 103 days• Need short-term finance for 103 days

Homework

• Question 12.17 p44• Q&A Bank Part 3 Q3.1- 3.9, 3.12 – 3.15• Question 3.28, 3.29

Class test• Monday 12 May 2014 (During lecture

time)• Only on Chapter 12• Multiple choice questions• Calculations and theory!!!• Total 20 marks• 30 minutes