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Hello Sir, can you please specify whether it is true what I have written:
[Point 1] Is it true that we can identify the company’s excessive investment in Long-term Assets by simply taking out the increase in Non-current Assets [we don’t have to calculate any ratio for that?]
[Point 2] If we have financed working capital from short-term finance then we can clearly see the increase in current liabilities to identify [we don’t have to calculate any ratio?]
[Point 3] Simply seeing the increase in working capital (which is current assets – current liabilities) with a corresponding increase in short-term borrowing can clearly identify that whether the company has spent its short-term borrowing on working capital or not?
[Point 4] If the company has increased in long-term Borrowings to finance its Long-term Assets [Is there any ratio for that to know whether the company has spent its long-term borrowing on long-term assets or not – we just see that by the increase in long-term assets with the corresponding increase in long-term borrowing. right?]
Point 1: I do not understand what you have written because long-term assets are non-current assets.
Point 2: True
Point 3: No. Current liabilities include short-term borrowings.
Point 4: There is no ratio. The total increase in long-term finance (equity plus non-current liabilities) will have either been used to increase non-current assets, or to increase the working capital, or both. By looking at the SOFP you are able to see what it is the money has been used for.
Point 1 was a typing error. Let me correct it.
[Point 1]
Is it true that we can identify the company’s policy whether the company is using long-term or short-term borrowings by looking at the increase & decrease of either the long-term or short-term Borrowing [Because the company can adopt any one of them], Either invest long-term borrowing in long-term assets which can be indicated by the increase in both long-term borrowing & long-term assets to earn profits for long-term prospects.Or If the company is investing short-term borrowing in Working Capital [to maintain liquidity problems within the company] which can be indicated by the increase in both short-term borrowing & working capital. [true?]
I don’t understand your statement about point 3. Let me rephrase.
[Point 3]
If a company has raised finance from short-term borrowing which will increase Short-term Borrowing [Current Liabilities] of the company AND therefore, it invests it in working capital for liquidity issues. Isn’t Working Capital be increased because we have already invested in it along with the short-term borrowing?Point 1 is correct.
For point 3 it is not a question of investing short term borrowing in working capital.
The potential problem is that the company is forced into using overdraft finance (short-term borrowings) because the current assets have increased (due to increased business) but they have not raised the necessary extra long-term finance.The important thing for the exam is what I wrote in my first reply in reference to your point 4.
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