WCR, CFC

Question 1

Working capital ratio (WCR)

Answer 1

A liquidity indicator that measures the ratio of current assets to current liabilities to assess the firm’s ability to meet its short-term debts as they fall due
formula:
current assets/current liabilities

Question 2

Assessing business performance using WCR

Answer 2

• If WCR is less than 1:1 this means the business has less than $1 in assets for every $1 of current liabilities and could struggle to meet their short term debts
• If WCR is much greater than 1:1 the firm may have excess current assets that are idle or not being employed effectively
  
  • Bank: cash sitting idle when it could be used to generate more revenues or to make other investments
  • Inventory: excess inventory could incur additional storage costs and increase the risk of damage
  • Accounts receivable: the longer it takes for AR to pay, the the higher the risk of not being able to collect debt

Question 3

Strategies to improve WCR

Answer 3

• too low (below 1:1):
  
  • improve cash flow from ops
  • reduce drawings or encourage a capital cont.
  • renegotiate ST debts to become LT
• too high (above 2:1):
  
  • reduce inventory of materials
  • reinvest excess cash
  • drawings

Question 4

Cash Flow Cover

Answer 4

• A liquidity indicator that assesses the firm’s ability of the business’s operating cash flows to meet its short-term debts as they fall due
  The indicator assesses the liquidity by calculating the number of times average current liabilities can be met using net cash flows from operations
  formula: