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Order Placed Order Received < Inventory > Payment Sent Cash Received Accounts Collection < Receivable > < Float > Sale
Time ==>
Accounts < Payable > Disbursement < Float >
Invoice Received
Learning Objectives
Differentiate between solvency and liquidity ratios Conduct a liquidity analysis Assess a firms financial flexibility position
Solvency Measures
Current Ratio
Current assets Current ratio = ------------------------Current liabilities $8,924 Current ratio = ------------ = 1.00 $8,933 1999 1.72 2000 1.48 2001 1.45 2002 1.05 2003 1.00
Current ratio
Quick Ratio
Current assets - Inventories Quick ratio = ------------------------------------Current liabilities $8,924 - $306 Quick ratio = ------------------- = .96 $8,933 1999 1.64 2000 1.40 2001 1.39 2002 1.01 2003 0.96
Quick ratio
($000,000) 1999 2000 2001 Net working capital $2,644 $2,489 $2,948
2002 $358
2003 ($9)
NWC = CA - CL
($2,586+$306+$1,394) - ($5,989+$54+$1,458+$1,432) WCR/S = ------------------------------------------------------------------$35,404 ($4,647) ---------- = -.1313 $35,404 1999 2000 2001 2002 - 0.029 -0.065 -0.078 -0.114 2003 -0.131
WCR/S
1999 2000 2001 2002 2003 $3,181 $4,132 $5,438 $3,914 $4,638
What is Liquidity?
Ingredients
Time Amount Cost
Definition
Having enough financial resources to cover financial obligations in a timely manner with minimal costs
Amount and trend of internal cash flow Aggregate available credit lines Attractiveness of firms commercial paper and other financial instruments Overall expertise of management
Liquidity Measures
Cash Flow From Operations Cash Conversion Efficiency Cash Conversion Period
($ 000,000) CFFO
1999 2000 2001 2002 2003 $2,436 $3,926 $4,195 $3,797 $3,538
(Percentage of sales) Operating profit margin 11.21 Net profit margin 8.00 Cash conversion efficiency 13.35
Inventory stocked
Inventory sold
Cash received
Solvency - a stock or balance perspective Liquidity - a flow perspective Liquidity management involves finding the right balance of stocks and flows
Cash assets t-1 + CFFO t CLI = --------------------------------N/P t-1 + CMLTD t-1 $4,638 + $3,538 CLI = --------------------- = infinite $0 + $0
Lambda
Initial liquid Total anticipated net cash flow reserve + during the analysis horizon Lambda = ------------------------------------------------------------------Uncertainty about the net cash flow during the analysis horizon
Financial Flexibility
Sustainable Growth Rate Concept: Uses New Assets gS(A/S) = Sources = New Equity + New Debt = m(S+gS)(1-d) + m(S+gS)(1-d)(D/E) m(1-d)[1 + (D/E)] g = ---------------------------------(A/S) - {m(1-d)[1 + (D/E)]} .039977 x (1 - 0.00) x (1 + 1.8834) g = ----------------------------------------------------- = 36.14% .43426 - [0.039977 x (1 - 0.00)(1 + 1.8834)] calculation uses 2002 data to calculate the sustainable 2003 g. Copyright 2005 by Thomson Learning, Inc.
Summary
Solvency: an accounting concept comparing assets to liabilities. Liquidity: related to a firms ability to pay for its current obligations in a timely fashion with minimal costs. Financial flexibility: related to a firms overall financial structure and if financial policies allows firm enough flexibility to take advantage of unforeseen opportunities.