6-3
Chapter 6
Liquidity of Short-Term Assets; Related Debt-Paying Ability
Current Assets, Current Liabilities, and the Operating Cycle
¢ Current assets
£ Are in the form of cash
£ Will be realized in cash
£ Conserve the use of cash within the operating cycle of a business or one year, whichever is longer
¢ Operating cycle
£ The time period between the acquisition of goods and the final cash realization resulting from sales and subsequent collections
¢ Cash
¢ Marketable Securities
£ Readily marketable; intent of management to convert to cash within the current operating cycle or one year, whichever is longer
£ May be in equity or debt
£ Carried at fair value
Nike, Inc.: Marketable Securities (Short-Term Investments)
¢ Receivables
£ Trade receivables arise from sales transactions
£ Short-term notes receivable arise from various lending activities
£ The valuation of current receivables ignores time value discounting
£ Receivables are reported net of estimated uncollectible amounts through use of an Allowance for Doubtful Accounts
£ The currently-due portion of installment receivables is reported as a current asset
Computer Associates International, Inc. and Subsidiaries Consolidated Balance Sheets: Installment Receivables
£ Days’ sales in receivables
Nike, Inc.: Days’ Sales in Receivables
£ Accounts receivable turnover
Nike, Inc.: Accounts Receivable Turnover
£ Accounts receivable turnover in days
Nike, Inc.: Accounts Receivable Turnover in Days
£ Credit sales versus cash sales
o Mingling of cash and credit sales in public reports makes assessment of liquidity difficult
¢ Inventories
£ Assets held for sale in the normal course of business or used or consumed in the production of goods
£ Perpetual inventory system
o A continuous record of goods is maintained and verified by periodic physical inventory
£ Periodic inventory system
o Ending inventory is determined through physical count and application of historical cost derived from one of several cost flow assumptions
£ Inventory cost
o First-in, first-out (FIFO)
Cost of sales are measured at the oldest and typically least expensive acquisition costs
Ending inventory is carried at a higher value
o Last-in, first-out (LIFO)
Cost of sales are measured at the most recent (e.g., higher) acquisition costs
Ending inventory is carried at a lower value
o Average cost
Cost of goods sold and ending inventory are based on the same weighted or average unit cost
o Specific identification
Items of inventory are identified from the specific purchase and related cost of that purchase
£ Lower-of-cost-or-market rule
o Write-down of inventory when utility is less than less than its cost
o The loss is recognized in the period the loss occurs
£ Liquidity of inventory
o Days’ sales in inventory
Nike, Inc.: Days’ Sales in Inventory
o Inventory turnover
Nike, Inc.: Merchandise Inventory Turnover
o Inventory turnover in days
Nike, Inc.: Inventory Turnover in Days
£ Operating cycle
o The time between acquisition of goods and the final cash realization from sales
o Accounts Receivable Turnover in Days + Inventory Turnover in Days
Nike, Inc.: Operating Cycle
¢ Prepayments
£ Unexpired costs for which payment has been made and which are expected to be consumed within the operating cycle or one year, whichever is longer
¢ Other Current Assets
£ Current assets other than cash, marketable securities, receivables, inventories, and prepayments
¢ Current Liabilities
£ Obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets or the creation of other current liabilities
Current Assets Compared with Current Liabilities
¢ Working Capital
£ Current Assets – Current Liabilities
Nike, Inc.: Working Capital
¢ Current Ratio
Nike, Inc.: Current Ratio
¢ Acid-Test Ratio (Quick Ratio)
Nike, Inc.: Acid-Test Ratio
£ Acid-test ratio conservative
Nike, Inc.: Acid-Test Ratio (Conservative Approach)
£ Cash Ratio
Nike, Inc.: Cash Ratio
Other Liquidity Considerations
¢ Sales to Working Capital (Working Capital Turnover)
Nike, Inc.: Sales to Working Capital
¢ Liquidity Considerations Not on the Face of the Statements
£ Liquidity may be better than indicated by financial statements
£ Liquidity may be weaker than indicated by financial statements