1 Copyright © 2013 McGraw-Hill Ryerson Limited LO4Use financial ratios to analyze performance LO5Use financial ratios to analyze liquidity. LO6Use financial ratios to analyze solvency and leverage. LO7Use financial ratios to analyze market measures of and dividends of entities. LO8Recognize the limitations of financial statements and ratio analysis in evaluating an entity. LO9 Understand how the flexibility of accounting rules, even under IFRS, allow managers to manage the earnings of their entities and thereby affect the numbers reported and information disclosed in the financial statements. Learning Objectives

2 Liquidity The availability of cash and near-cash resources Necessary for making payments that come due Ratios and notes to financials important in assessing liquidity Copyright © 2013 McGraw-Hill Ryerson Limited LO5

3 Liquidity Current ratio Measure of resources entity has to meet current obligations = Current assets Current liabilities Acid test ratio Quick assets includes cash, temporary investments, accounts receivable and any other asset than can be quickly converted into cash = Quick assets Current liabilities Copyright © 2013 McGraw-Hill Ryerson Limited LO5

4 Accounts receivable turnover ratio ▫Indicates how quickly receivables are collected = Credit sales Average AR Average collection period ▫Number of days it takes to collect receivables = 365/AR turnover Copyright © 2013 McGraw-Hill Ryerson Limited Liquidity LO5

5 Inventory turnover ratio = Cost of sales Average inventory Days inventory on hand = 365/inventory turnover ratio Accounts payable turnover =Credit purchases Average AP Average payment period for AP = 365/AP turnover ratio Copyright © 2013 McGraw-Hill Ryerson Limited LO5 Liquidity

6 Cash Lag ▫Larger cash lags means longer period of self- financing ▫Lag likely increase during financial distress = Avg. collection period AR + Avg. days inventory on hand – Avg. payment of AP Copyright © 2013 McGraw-Hill Ryerson Limited Liquidity LO5