FSA_ Class Discussion_Session 2

Performance of company depends

Liquidity
Solvency
Efficiency
Profitability
Liquidity Analysis
1. Is the company using CL to finance its assets?
a. Determine the Working Capital
b. WC = CA-CL
i. Negative
1. Part of the LTA financed by the CL
a. Examine the composition of CL
b. CL = Creditors/OS expenses/ Advance
from customers/STL/Bank OD/ Credit
card loans
i. IBCL
ii. NIBCL
ii. Positive
1. PARt of the CA financed by the LTS
iii. Zero

FSA_ Class Discussion_Session 2

2. What is the ability of the company to meet the CL?
a. Determine Current Ratio
b. CR = CA/CL
c. General rule of interpreting CR: Higher the CR better
is the liquidity
d. However, while interpreting CR one has to recognize
the limitations of CR
i. Window dressing: showing better position by
using accounting assumptions
1. This limitation can be addressed by
removing the items which can be subject to
the accounting assumptions
a. Liquid Ratio =(CA-Stock)/CL
b. ABCR= (CA-Stock Debtors)/CL
c. ABCR =(Cash +near Cash items)/CL

ii. Focus on the quantity and ignores the quality of

CA
1. The limitation can be addressed by
examining the quality of
Debtors/Stock/Creditors
R
a. Debtor Days: no of days sales
remaining as debtors
i. A: DD =50: CD =40
ii. B: DD =100: CD = 150

FSA_ Class Discussion_Session 2

b. Inventory Days no of days sales
remaining as inventory
i. Inventory/Cost of sales per day
c.
d. Creditor Days
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FSA_ Class Discussion_Session 2

Performance of an entity is reflected by
Liquidity
Solvency
Efficiency
Profitability
Liquidity Analysis
Understanding the composition of CA and CL
Ability to meet short term obligations
Issues for discussion under LA`
Is the company using the CL to finance its assets?
o Working capital
CA CL
Positive WC
Part of the CA are financed by the LTS
Negative WC
Part of the LTA are financed by the CL
Zero WC
CA are fully financed by the CL
o Now examine the components of CL
CL = Creditors/OS expenses/Bills
payables/Advance from customers/ STL/Bank
overdraft
o IBCL
o NIBCL
Is the company has the ability to meet the CL?
o Find Current Ratio = CA/CL
o General rule for interpretation of CR:

FSA_ Class Discussion_Session 2

Higher the CR better is the liquidity
However, the while interpreting the CR one has
to recognize the limitations of the CR which are
as follows:
Problem of window dressing (Showing
better picture through accounting
assumptions)
o This limitation can be addressed by
removing the items from CA which are
subject to accouting assumptions
(CA Stock )/CL = Liquid Ratio
(CA Stock Debtors)/CL =
Absolute Cash Ratio
Or
(Cash + near cash items )/CL =
ABCR
Focus on the quantity of CA and ignores the
quality
o This limitation can be addressed by
examining the quality of
Debtors/Stock/Creditors
Debtors Days = Average
Debtor/Sales per day
A: DD: 55 CD = 45
B : DD :165; CD =200
Inventory: How days of sales
remain in the inventory
Average inventory/Cost of
sales per day

FSA_ Class Discussion_Session 2

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FSA_ Class Discussion_Session 2

Performance of a company depends on the following
Liquidity
Solvency
Efficiency
Profitability
Liquidity Analysis
Financing: Is the company using CL to finance its assets?
o Determine the Working Capital
o WC = CA CL
Positive
Part of the CA are financed by LTS
Negative
Part of the LTA are financed by the CL
o Examine the composition of CL
o CL = Creditors/OS expenses/ Adv from
Customers/STL/Bank OD/Cash
credits/Credit Cards
IBCL
NIBCL
Zero
CA are fully financed CL
LTA are financed by LTS

FSA_ Class Discussion_Session 2

Liquidity: Is the company have sufficient CA to meet the
CL?
o Determine Current Ratio = CA/CL
o General rule of interpretation of CR: Higher the CR
better is the liquidity
Examine the components of CA
o While interpreting CR one has to recognize the
limitations of CR
Window dressing: Showing better postion
through accounting assumption
This limitation can be addressed by
removing the items that are subject to
accounting assumptions
o Liquid Ratio: (CA Stock)/CL
o ABCR = (CA-Stock Debtor)/CL
o ABC R = (Cash + near Cash items)/CL
Focus on quantity rather than quality
Examine the quality of Debtors/
Stock/Creditors
o DD: Average Debtors/Sales per day
A: DD = 50 CD = 30
B: DD = 100 CD 150
o Inventory Days: number of days of
sales remaining as Inventory
Average stock/Cost of sales per
day

FSA_ Class Discussion_Session 2

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