Question

88. What is the conclusion to draw from this data? Current Ratio 1.07 1.20 1.00 0.80 0.60 0.40 0.20 0.00 0.59 0.52 0.37 2017 2018 Plan Industry

Answer 1

88.

Current ratio is given by the formula:

$Current \, \, ratio=\frac{Current \, \, assets}{Current \, \, liabilities }$

This is a liquidity ratio and gives a sense of how good the liquidity position of an organisation is. A current ratio of less than 1, suggests that the company in question has fewer current assets (cash, liquid securities, accounts receivables etc.) than its current liabilities (the money it needs to pay up in the coming future). This means that our company might face trouble financing its day to day operations.

In the given chart, the industry current ratio is 1.07 whereas the company's current ratio is 0.59 in 2017 and 0.52 in 2018. This clearly suggests that this company is facing solvency issues and its liquidity position is actually worsening. The fact that industry average is over 1 further vindicates that this company will need to better finance its working capital and will have to work on improving its operations.

89.

Inventory turnover ratio is given as:

$Inventory\: turnover = \frac{Sales/COGS}{Average \: inventory}$

This ratio gives an idea about how many times a company has able to sell or replace its inventory in a given period. A low inventory ratio might imply low sales or excess inventory both of which are problems that need fixing. Holding excess inventory unnecessarily blocks capital which could have been better used elsewhere. So, companies could use this ratio in order to optimize their inventory allocation.

Inventory turnover can be calculated using either sales or COGS in the numerator. Sales include COGS and gross profit and so is higher. In the given chart, our company has almost the same inventory turnover (COGS) as the industry which is a neutral signal. Also the fact that Inventory turnover (Sales) for our company is much more than the industry average than in the case of COGS is interesting. It means that this company enjoys a higher than average gross profit margin which a great sign.

90.

Accounts receivable days is given by the formula:

$Accounts \:receivable\: days = \frac{Avg.\: accounts\: receivable}{Credit\: sales} * 365\: days$

This ratio signifies the number of days it takes for a company to collect payments on its credit sales. A lower ratio is what a company would usually like to have. But there is a trade off. A lower credit period might result in customers going to the competition in search for better credit terms.

In the given chart, industry average is quite larger than our company's ratio which might mean that this company is not offering an acceptable credit period or maybe that it is too good in collecting payments.