Asset & Liabilities Management Chapter 2

7/29/2019 Asset & Liabilities Management Chapter 2

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Copyright 2005 by Thomson Learning, Inc.

Chapter 2Analysis of Solvency, Liquidity, and

Financial Flexibility

Order Order Sale Payment Sent Cash

Placed Received ReceivedAccounts Collection

< Inventory > < Receivable > < Float >

Time ==>

Accounts Disbursement

< Payable > < Float >

Invoice Received Payment Sent Cash Disbursed


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Learning Objectives

Differentiate between solvency and liquidity ratios

Conduct a liquidity analysis

Assess a firms financial flexibility position


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Financial Statements - Basic Sourceof Information

Balance Sheet

Income Statement

Statement of Cash Flows


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Solvency Measures

Current Ratio

Quick Ratio

Net Working Capital

Net Liquid Balance

Working Capital Requirements


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Current Ratio

Current assets

Current ratio = -------------------------Current liabilities

$8,924

Current ratio = ------------ = 1.00

$8,933

1999 2000 2001 2002 2003

Current ratio 1.72 1.48 1.45 1.05 1.00


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Quick Ratio

Current assets - Inventories

Quick ratio = -------------------------------------Current liabilities

$8,924 - $306

Quick ratio = ------------------- = .96

$8,933

1999 2000 2001 2002 2003

Quick ratio 1.64 1.40 1.39 1.01 0.96


7/22Copyright 2005 by Thomson Learning, Inc.

Net Working Capital

Net working capital = CA - CL

Net working capital = $8,924 - $8,933

= ($9)

($000,000) 1999 2000 2001 2002 2003

Net working capital $2,644 $2,489 $2,948 $358 ($9)



NWC and its Component Parts

Cash

Mkt Sec

A/R

Inventory

Prepaid

A/P

N/P

CMLTD

Cash

Mkt Sec

A/R

Inventory

Prepaid

A/P

N/P

CMLTD

Cash

Mkt Sec

A/R

Inventory

Prepaid

A/P

N/P

CMLTD

CA CL CA CL CA CL

NWC = CA - CL WCR = A/R + INV +Pre NLB = Cash + M/S

- A/P - N/P - CMLTD

Net Working Capital Working Capital Requirements Net Liquid Balance



Working Capital Requirements

($2,586+$306+$1,394) - ($5,989+$54+$1,458+$1,432)

WCR/S = -------------------------------------------------------------------$35,404

($4,647)

= ---------- = -.1313

$35,404

1999 2000 2001 2002 2003

WCR/S - 0.029 -0.065 -0.078 -0.114 -0.131



Net Liquid Balance

Net liquid balance = Cash + Equiv. - (N/P + CMLTD)

Net liquid balance = $4,638 - ($0)

= $4,638

($000,000) 1999 2000 2001 2002 2003

Net liquid balance $3,181 $4,132 $5,438 $3,914 $4,638



What is Liquidity?

Ingredients Time

Amount

Cost

Definition Having enough financial resources to cover financial obligations

in a timely manner with minimal costs



What is Liquidity - Examples

Amount and trend of internal cash flow

Aggregate available credit lines

Attractiveness of firms commercial paper andother financial instruments

Overall expertise of management



Liquidity Measures

Cash Flow From Operations

Cash Conversion Efficiency

Cash Conversion Period

Current Liquidity Index

Lambda



Cash Flow From Operations

($ 000,000) 1999 2000 2001 2002 2003

CFFO $2,436 $3,926 $4,195 $3,797 $3,538



Cash Conversion Efficiency

($ 000,000) 1999 2000 2001 2002 2003

CFFO $2,436 $3,926 $4,195 $3,797 $3,538

Revenues 18,243 25,265 31,888 31,168 35,404Operating profit 2,046 2,457 2,768 2,271 2,844

Net profit 1,460 1,666 2,177 1,246 2,122

(Percentage of sales)

Operating profit margin 11.21 9.72 8.68 7.28 8.03

Net profit margin 8.00 6.59 6.82 3.99 5.99

Cash conversion efficiency 13.35 15.54 13.15 12.18 9.99

Cash conversion efficient = CFFO / Sales



Cash Conversion Chart

Inventory Inventory Cash

stocked sold received

Days inventory held Days sales outstanding

Days payables outstanding Cash conversionperiod

Cash

disbursed


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Cash Conversion PeriodCalculations

Cash conversion period = DIH + DSO - DPO

(Days) 1999 2000 2001 2002 2003DIH 7.10 7.17 5.79 3.99 3.87

DSO 49.64 38.69 33.14 26.57 26.66

------- ------- ------- ------- -------

Operating cycle 56.74 45.86 38.93 30.56 30.53DPO 62.34 64.92 62.07 72.87 75.79

------- ------- ------- ------- -------

Cash conversion period -5.60 -19.06 -23.14 -42.31 -45.26


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How Much Liquidity is Enough?

Solvency - a stock or balance perspective

Liquidity - a flow perspective

Liquidity management involves finding the rightbalance of stocks and flows


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Current Liquidity Index

Cash assets t-1 + CFFO t

CLI = ---------------------------------N/P t-1 + CMLTD t-1

$4,638 + $3,538

CLI = --------------------- = infinite

$0 + $0


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Lambda

Initial liquid Total anticipated net cash flow

reserve + during the analysis horizon

Lambda = -------------------------------------------------------------------

Uncertainty about the net cash flow during theanalysis horizon


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Financial Flexibility

Sustainable Growth Rate Concept:

Uses = Sources

New Assets = New Equity + New Debt

gS(A/S) = m(S+gS)(1-d) + m(S+gS)(1-d)(D/E)

m(1-d)[1 + (D/E)]

g = ----------------------------------

(A/S) - {m(1-d)[1 + (D/E)]}

.039977 x (1 - 0.00) x (1 + 1.8834)

g = ----------------------------------------------------- = 36.14%

.43426 - [0.039977 x (1 - 0.00)(1 + 1.8834)]

calculation uses 2002 data to calculate the sustainable 2003 g.


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Copyright 2005 by Thomson Learning Inc

Summary

Chapter introduced basic concepts of: solvency

liquidity

financial flexibility

Solvency: an accounting concept comparing assetsto liabilities.

Liquidity: related to a firms ability to pay for itscurrent obligations in a timely fashion with

minimal costs. Financial flexibility: related to a firms overall

financial structure and if financial policies allowsfirm enough flexibility to take advantage of

unforeseen opportunities.

Asset & Liabilities Management Chapter 2

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