WORKING CAPITAL=CURRENT ASSETS-CURRENT LIABILITIES Flashcards
(43 cards)
CURRENT RATIO FORMULA
CURRENT ASSETS/CURRENT LIABILITY
QUICK RATIO FORMULA
CASH+MARKETABLE SECURITIES+RECEIVABLES/CURRENT LIABILITIES(INVENTORY AND PREPAIDS ARE EXCLUDED FROM CURRENT ASSETS)
APR OF QUICK PAYMENT DISCOUNT(annual cost)
360/pay period-discount period*discount/100-discount%
what is a spontaneous source of credit
ACCOUNTS PAYABLE(trade credit)
current assest consists of
accounts receivable, cash, inventory, and prepaid expense
current liabilities consists
Accounts payable, interest payable due in3 mon
short term investments except
convertible bonds(maturity date is usually more than a year)
decrease in current ratio
increase in short term debt,decrease in current assets or combination of both
improving current ratio
long term borrowing to repay short term debt
ACCOUNTS RECEIVABLE TURNOVER RATIO
NET SALES/AVERAGE ACCOUNTS RECEIVABLE
RECEIVABLES COLLECTION PERIOD=DSO
DSO=365/AVERAGE ACCOUNTS RECEIVABLE TURNOVER
working capital management and working capital policy involve
managing cash so that company can meet its short-term obligations ,and include all aspects of the administration of current assets and current liabilities.
goal of working capital management
shareholder wealth maximization
optimal mix of ca and cl
offsetting the benefit of ca and cl against the probability of technical insolvency
AGGRESIVE WORKING CAPITAL POLICY
INCREASE THE RATIO CURRENT LIABILITIES TO NON CURRENT LIABILITIES (more current assets financed with current liabilities)
conservative working capital policy
increase the ratio of current assets to non current assets(more current assets financed by noncurrent liabilities)
if the ratio is less than 1,
paying off current liabilities with current assets results in equal decrease in numerator and denominator. the effect is to decrease the current ratio.
if the ratio is greater than 1
paying off current liabilities with current assets results in equal decrease in numerator and denominator, the effect is to increase the current ratio
Farrow Co. is applying for a loan in which the bank requires a quick ratio of at least 1. Farrow’s quick ratio is 0.8. Which of the following actions would increase Farrow’s quick ratio(increase quick ratio)
Selling obsolete inventory at a loss.
Answer (D) is correct.
The quick (acid-test) ratio equals the sum of (1) cash and cash equivalents, (2) marketable securities, and (3) net receivables, divided by current liabilities. Inventory is not included in the numerator of the quick ratio. Receiving cash from the sale of inventory, even at a loss, increases quick assets without affecting current liabilities. The effect is to increase the quick ratio.
Depoole’s collection of a current accounts receivable of $29,000 will(firm is at profit)
Answer (B) is correct. no change in current ratio or in quick ratio.
Collecting current accounts receivable has no effect on either the current ratio or the quick ratio because assets (both current and quick) are reduced for the collection of receivables and increased by the same amount for the receipt of cash. Current liabilities are unchanged by the transaction.
If a firm increases balance by issuing additional shares ofits cash common stock, net working capital
Increases and the current ratio increases.
Answer (D) is correct.
Net working capital is the excess of current assets over current liabilities. The current ratio equals current assets divided by current liabilities. Selling stock for cash increases current assets and stockholders’ equity, with no effect on current liabilities. The result is an increase in working capital and the current ratio.
At December 30, Agnon Co. had cash of $200,000, a current ratio of 1.5:1, and a quick ratio of .5:1. On December 31, all cash was used to reduce accounts payable. How did these cash payments affect the ratios
Increased
Decreased
Answer (B) is correct.
The current ratio (1.5) equals current assets (cash, net accounts receivable, current marketable securities, certain available-for-sale and held-to-maturity securities, inventory, prepaid expenses) divided by current liabilities (accounts payable, etc.). If a ratio is greater than 1.0, equal decreases in the numerator and denominator (debit accounts payable and credit cash for $200,000) increase the ratio. The quick ratio (.5) equals quick assets divided by current liabilities. If a ratio is less than 1.0, equal decreases in the numerator and denominator (debit accounts payable and credit cash for $200,000) decrease the ratio.
Mogul Co. wrote off obsolete inventory during the current year. What was the effect of this write-off on Mogul’s ratio analysis?
D. Decrease in current ratio but not in quick ratio.
Answer (D) is correct.
The entry is to debit a loss and credit inventory, an asset that is included in the numerator of the current ratio but not the quick ratio. Hence, the write-off decreases the current ratio but not the quick ratio.
Depoole Company is a manufacturer of industrial products that uses a calendar year for financial reporting purposes. Assume that total quick assets exceeded total current liabilities both before and after the transaction described. Further assume that Depoole has positive profits during the year and a credit balance throughout the year in its retained earnings account.
Question: 16 Depoole’s purchase of raw materials for $85,000 on open account
Decrease the current ratio.
Answer (D) is correct.
The purchase increases both the numerator and denominator of the current ratio by adding inventory to the numerator and payables to the denominator. Because the ratio before the purchase was greater than 1, the ratio is decrease.
