A. Short-Term Liquidity Risk: Discuss current ratio, quick ratio, operating cash
ID: 2459286 • Letter: A
Question
A. Short-Term Liquidity Risk: Discuss current ratio, quick ratio, operating cash flow to 1. current liabilities ratio, days accounts receivable, days in inventory, days accounts payable in addressing this risk.Then, provide a concluding sentence summarizing this risk.
B. Long-Term Solvency Risk: Discuss long-term debt ratios, operating cash flow to total liabilities, interest rate coverage ratio in address this risk. Then, provide a concluding sentence summarizing this risk.
C. Bankruptcy Risk: Discuss Altman’s Z-score. Then, provide a concluding sentence summarizing this risk.
1 ) Current Ratio = Current assets / current laibilities
=4200 / 2210, =1.90
2) Quick ratio = Liquid assets / current liabilities
Liquid assets= current assets - inventory - prepaid expenses - deffered tax asset
= 4200 - 1242 - 197 - 239 ,= 2522
quick ratio = 2522 / 2210, =1.14
3) Operating cash flow to current liabilities
operating cassh flow = 1750
current liabilities = 2210
ratio = 1750 / 2210 ,= 0.79
4) Days Accounts receivable outstanding
= (Average receivables / Sales - speciality ) x 365 days
Average receivables = ( opening receivables + closing receivables) / 2
= (387 +486) / 2, = 436.50
Sales - speciality = 1210 + 1555, = 2765
days receivable outstanding = (436.50 / 2765) x 365, = 58 days
5) days inventory held = (Average stock / COGS) x 365
Avearage stock = ( opening stock + closing stock ) / 2
=(966 +1242) / 2, = 1104
days inventory held = (1104 / 5813) x 365, = 69 days
6) days accounts payable = (Average payables / COGS) x 365
Average payables = ( opening payables + closing payables) / 2
= (540+398) /2, = 469
days accounts payable = (469 / 5813) x 365 , = 29 days
7) Net days of working capital financing needed
Days of accounts receivable +dayss of inventory held - days of accounts payable
= 58 + 69 - 29, = 98
8) Liabilities to asset ratio
Total Liability = 3105
Total asset =8219
Total liability / total asset = 3105 / 8219, = 0.38
9) Liabilities to shareholders fund
Shareholders fund = 5109
= Total Liabilities / shareholders fund, = 3105 / 5109, =0.61
10 ) Long term debt to long term capital
LOng term debt = 550
long term capital = long term debt + shareholders funf, = 550 +5109, = 5659
Long term debt / long term capital
550 /5659,= 0.10
11) Long term debt to equity
= long term debt / shareholders fund
= 550 / 5109, = 0.11
12 Interest coverage ratio = EBIT/ Interest expense
EBIT = 1997 +94 ( interest received) = 2091
interest expense = 33
ratio = 2091 / 33, = 63.36
13) opearting cash flow to total liabilities
= 1750 / 2210 , = 0.79
Explanation / Answer
Answer
Answer A.
Short-Term Liquidity Risk: Discuss current ratio, quick ratio, operating cash flow to 1. current liabilities ratio, days accounts receivable, days in inventory, days accounts payable in addressing this risk. Then, provide a concluding sentence summarizing this risk.
1 ) Current Ratio = Current assets / current laibilities
=4200 / 2210, =1.90
Answer : Current ratio is above standard of 1.33 times which is comfortable.
2) Quick ratio = Liquid assets / current liabilities
Liquid assets= current assets - inventory - prepaid expenses - deffered tax asset
= 4200 - 1242 - 197 - 239 ,= 2522
quick ratio = 2522 / 2210, =1.14
Answer : Quick Ratio is at 1.14 times is comfortable.
3) Operating cash flow to current liabilities
operating cassh flow = 1750
current liabilities = 2210
ratio = 1750 / 2210 ,= 0.79
Answer : operating cash flow to current liabilities is below 1 but still within comfort level.
4) Days Accounts receivable outstanding
= (Average receivables / Sales - speciality ) x 365 days
Average receivables = ( opening receivables + closing receivables) / 2
= (387 +486) / 2, = 436.50
Sales - speciality = 1210 + 1555, = 2765
days receivable outstanding = (436.50 / 2765) x 365, = 58 days
Answer : Accounts receivables of 58 days shows credit sales payment is received within 58 days.
5) days inventory held = (Average stock / COGS) x 365
Avearage stock = ( opening stock + closing stock ) / 2
=(966 +1242) / 2, = 1104
days inventory held = (1104 / 5813) x 365, = 69 days
Answer : Inventory days shows cash invested in inventory will be recovered within 69 days.
6) days accounts payable = (Average payables / COGS) x 365
Average payables = ( opening payables + closing payables) / 2
= (540+398) /2, = 469
days accounts payable = (469 / 5813) x 365 , = 29 days
Answer : Accounts payable days shows credit purchases payments are made within 29 days.
7) Net days of working capital financing needed
Days of accounts receivable +days of inventory held - days of accounts payable
= 58 + 69 - 29, = 98
Answer : Overall working capital days will be compared with industry average to know whether working capital cycle is efficient or not.
Summary on liquidity risk : Company has comfortable current and quick ratio but company has somewhat less operating cash flows to serve current liabilities. Overall working capital cycle must be compared with industrial average to know its efficiency level. Overall liquidity risk is lower.
Answer B.
Long-Term Solvency Risk: Discuss long-term debt ratios, operating cash flow to total liabilities, interest rate coverage ratio in address this risk. Then, provide a concluding sentence summarizing this risk.
8) Liabilities to asset ratio
Total Liability = 3105
Total asset =8219
Total liability / total asset = 3105 / 8219, = 0.38
Answer : Liabilities to asset ratio is comfortable at 0.38times signifying lower external debt financing.
9) Liabilities to shareholders fund
Shareholders fund = 5109
= Total Liabilities / shareholders fund, = 3105 / 5109, =0.61
Answer : Total liabilities to shareholders fund is comfortable at 0.61 times.
10 ) Long term debt to long term capital
LOng term debt = 550
long term capital = long term debt + shareholders funf, = 550 +5109, = 5659
Long term debt / long term capital
550 /5659,= 0.10
Answer : Long term debt to long term capital is also comfortable at 0.10 times
11) Long term debt to equity
= long term debt / shareholders fund
= 550 / 5109, = 0.11
Answer : Long term debt to equity is comfortable at 0.11 times.
12 Interest coverage ratio = EBIT/ Interest expense
EBIT = 1997 +94 ( interest received) = 2091
interest expense = 33
ratio = 2091 / 33, = 63.36
Answer : Interest coverage ratio more than 6 times is considered as comfortable. So here interest coverage of 63.36 times is very comfortable.
13) opearting cash flow to total liabilities
= 1750 / 2210 , = 0.79
Answer : operating cash flow to total liabilities is below 1 but still within comfort level.
Summary long term solvency risk : Liabilities to asset ratio, Liabilities to shareholders fund, Long term debt to long term capital, Long term debt to equity, operating cash flow to total liabilities are comfortable showing very less financial leverage. So long term solvency risk is low. Very high interest coverage ratio shows very comfortable debt service repayment capability of company. So overall long term solvency risk is lower.
Answer C.
Bankruptcy Risk: Discuss Altman’s Z-score. Then, provide a concluding sentence summarizing this risk.
Answer:
The Altman Z-score is the output of a credit-strength test that gauges a publicly traded manufacturing company's likelihood of bankruptcy. The Altman Z-score, is based on five financial ratios that can be calculated from data found on a company's annual 10K report.
The Altman Z-score is calculated as follows:
Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E
Where:
A = Working Capital/Total Assets
B = Retained Earnings/Total Assets
C = Earnings Before Interest & Tax/Total Assets
D = Market Value of Equity/Total Liabilities
E = Sales/Total Assets
A score below 1.8 means the company is probably headed for bankruptcy, while companies with scores above 3.0 are not likely to go bankrupt. The lower/higher the score, the lower/higher the likelihood of bankruptcy.