Chapter05Sol 6e2005F
Chapter 5
Risk Analysis
CHAPTER 5
RISK ANALYSIS
Solutions to Questions, Exercises and Problems, and Teaching Notes to Cases
5 . 1 Relation between Current Ratio and Operating Cash Flow to Current
Liabilities Ratio. Both ratios use current liabilities in the denominator, although the current ratio using current liabilities at the end of a period and the cash flow ratio uses average current liabilities for the period. Thus, the explanation most likely relates to the numerator. The firm is probably growing and increasing inventories and accounts receivable, which increase the current ratio. However, the firm is not collecting cash from customers but having to pay suppliers of merchandise, which lowers cash flow from operations.
5.2 Relation between Current Ratio and Quick Ratio. The current ratio and the quick ratio both use current liabilities in the denominator. Thus, the explanation most likely relates to the numerator. The only differences in the numerator are that the current ratio includes inventories and prepayments, while the quick ratio does not. Sales growth has likely slowed or even decreased, so that the firm has reduced inventories and prepayments. The firm has collected cash from higher levels of accounts receivable of the previous period before the slowdown in sales and invested the cash in marketable securities.
5.3 Relation between Working Capital Turnover Ratios and Cash Flow from
Operations. The steady sales and net income should result in relatively constant addbacks for depreciation, deferred taxes, and other non-cash expenses. The decrease in the turnover of inventory coupled with the increase in the turnover for accounts payable means that the firm has purchased or produced inventory that is not selling as fast as previously, but the firm is paying for the inventory at a faster rate than previously. These actions will reduce cash flow from operations. The decrease in the accounts receivable turnover in light of steady sales indicates that
the
Risk Analysis
CHAPTER 5
RISK ANALYSIS
Solutions to Questions, Exercises and Problems, and Teaching Notes to Cases
5 . 1 Relation between Current Ratio and Operating Cash Flow to Current
Liabilities Ratio. Both ratios use current liabilities in the denominator, although the current ratio using current liabilities at the end of a period and the cash flow ratio uses average current liabilities for the period. Thus, the explanation most likely relates to the numerator. The firm is probably growing and increasing inventories and accounts receivable, which increase the current ratio. However, the firm is not collecting cash from customers but having to pay suppliers of merchandise, which lowers cash flow from operations.
5.2 Relation between Current Ratio and Quick Ratio. The current ratio and the quick ratio both use current liabilities in the denominator. Thus, the explanation most likely relates to the numerator. The only differences in the numerator are that the current ratio includes inventories and prepayments, while the quick ratio does not. Sales growth has likely slowed or even decreased, so that the firm has reduced inventories and prepayments. The firm has collected cash from higher levels of accounts receivable of the previous period before the slowdown in sales and invested the cash in marketable securities.
5.3 Relation between Working Capital Turnover Ratios and Cash Flow from
Operations. The steady sales and net income should result in relatively constant addbacks for depreciation, deferred taxes, and other non-cash expenses. The decrease in the turnover of inventory coupled with the increase in the turnover for accounts payable means that the firm has purchased or produced inventory that is not selling as fast as previously, but the firm is paying for the inventory at a faster rate than previously. These actions will reduce cash flow from operations. The decrease in the accounts receivable turnover in light of steady sales indicates that
the