Short- term Liquidity

Liquidity refers to the availability of company resources to meet Short term cash requirement A companys short-term liquidity refers to its ability to meet short Term obligations. Lack of liquidity can implies that the company is unable to take advantage of favorable discounts. It also implies limited opportunities and constraints on managements part. More extreme liquidity problems can lead to forced sale of investments and assets

When a companys owner possess unlimited liability lack of Liquidity endangers their personal assets.
To a creditor a lack of liquidity can delay in collecting interest and principal payments. Measure of liquidity: Current Ratio Relevance of the current ratio Current liability coverage Buffer against losses Reserve of liquid funds.

Limitations of the current ratio

Measure and predict the pattern of future cash inflows and outflows? Measure the adequacy of future cash inflows to outflows?

It is a static measure of resources available at a point in time

The current reserve of cash does not have logical or causal relation to its future cash inflows

Net trade cycle Analysis: A companys working capital requirements are affected by Its desired inventory investment and the relation between Credit terms and from suppliers and those extended to customers. These consideration determine a companys net trade cycle. This is the working capital management efficiency Tool.

Selected financial information from X company, for the end of Year 1

Sales for year 1 3,60,000

Receivables Inventories* A/P** Cost of goods sold(including depreciation of 30,000)

40,000 50,000 20,000 3,20,000

* Beginning inventory is 1,00,000 ** we assume these relate to purchase included in costs of goods sold.

We estimate companys purchases per day as:

Ending Inventory Cost of goods sold Less: beginning inventory Cost of goods purchased and manufactured Less: depreciation in cost of goods sold =Purchases 50,000 3,20,000 1,00,000 2,70,000 30,000 2,40,000

Purchases per day

2,40,000/360=666.67

The net trade cycle for X company (in days) Accounts receivable = 40,000/(3,60,000/360) = 40 days Inventories =50,000/(3,20,000/360)=56.24 days __________________________________________________ 96.24 days Less: Accounts payable=20,000/666.67 = Net trade cycle = 30 days 66.24 days

If the daily sales is (3,60,000 /360)=1000 then required working capital would be 1000*66.24 =66,240