1. Chapter 8 Activity and Liquidity

2. Financial Information Analysis2 Copyright 2006 John Wiley & Sons Ltd CASH Importance of cash ‘Cash is King’ Liquidity: ‘availability of cash in short term’ Capacity of firm to generate cash Activity: ‘efficient management of funds’ Efficiency of cash generation Liquidity and activity linked

3. Financial Information Analysis3 Copyright 2006 John Wiley & Sons Ltd Activity Quantifies trading activity in a way that recognises link with cash-generation Measures management efficiency Focus on management of short-term (current) assets and liabilities i.e. Working Capital Receivables Inventory Payables

4. Financial Information Analysis4 Copyright 2006 John Wiley & Sons Ltd Receivables Receivables: ‘claims to future cash’ Trade Receivables: ‘amounts due in respect of credit sales’ Receivables days: time taken to pay by credit customers: (Trade Receivables / Credit Turnover) x 365, or (Trade Receivables / Revenue) x 365 Firms will want to reduce this, i.e., ensure payment is received more quickly

5. Financial Information Analysis5 Copyright 2006 John Wiley & Sons Ltd Inventory Inventory: ‘resources held for sale’ Inventory management critical as cash tied-up Raw Material, W-I-P, Finished Goods Valuation: FIFO, LIFO, etc. Inventory days: time inventory held before sale (Inventory / Cost of Sales) x 365 Firms will want to reduce this Inventory turnover: times inventory converted into sales Cost of Sales / Closing Inventory Firms will want to increase this figure

6. Financial Information Analysis6 Copyright 2006 John Wiley & Sons Ltd Payables Payables: ‘obligations to pay cash’ Source of funds Attractive because often cost-free Should be funded by internally-generated cash Payables days: length of time taken by firm to pay (Trade Payables / Cost of Sales) x 365 Firms will want to increase this

7. Financial Information Analysis7 Copyright 2006 John Wiley & Sons Ltd Asset Turnover Management efficiency should also be related to overall asset management Asset Turnover relates Net Assets employed to revenue generated: Revenue/Net Assets Other variations available See also Chapter 10

8. Financial Information Analysis8 Copyright 2006 John Wiley & Sons Ltd Operating / Cash Cycles Possible to combine various activity ratios Operating Cycle: time before cash received Inventory days + Receivables days Cash Cycle: Inventory days + Receivables days - Payables days + = length of time operations must be funded - = length of time operations funded by others Cashflow Adequacy: Cash from Operating Activity/Current Liabilities Quality of Profits: relates profits to cash generation Cash from Operating Activity/Operating Profit

9. Financial Information Analysis9 Copyright 2006 John Wiley & Sons Ltd Liquidity ‘Capacity of business to pay short-term debt’ Related to cash-generating capacity Current Ratio: Current Assets / Current Liabilities x 100% Simple measure of liquidity Quick ratio: Current Assets - Inventory / Current Liabilities x 100% Removes least liquid asset from calculation Liquidity critical for survival Free Cash Flow: cash available after commitments

10. Financial Information Analysis10 Copyright 2006 John Wiley & Sons Ltd Summary ‘Working Capital’ section provides important information relating to liquidity Combined with trading figures it highlights management activity/efficiency All measures relate to cash management This is a critical management function Cash is King!