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The comparison between ratios of 2009 and 2010 shows:
1. * Payables’ payment time was 55 days in 2009 but increased to 83 days in 2010. So this means that we are taking longer now to pay our suppliers. So it is not good, right?
2. * Quick ratio was 3.25 in 2009 but fell to 1.5 in 2010. So, how do I interpret this? It means it is harder to liquify current assets in this year than it was in 2009. Right? And so liquidity/cash availability has deteriorated.
3. * Current ratio was 4.41 in 2009 but has reduced to 2.23 in 2010. So this also seems to be bad.
In this scenario, the business is in bad financial position.
Also, for working capital cycle; it went from 58 days in 2009 to 107 days in 2010. Is this bad and casts a doubt of going concern for the business . But how do i know that longer working capital days is bad??
Can you please explain this and further help me understand ratios so that I can do this in exam?
1. Yes – this is the “payables payment period” (in days) and it represents the average period of trade credit that the company takes. This should be in keeping with suppliers’ average credit terms, e.g. 30 days. Exceeding that by a few days is ok but too long and suppliers may withdraw supplying goods/services on credit and demand cash on delivery.
2. Yes – but as long as this ratio is greater than 1, the company should be able to meet its current liabilities (and so not of itself a cause for concern).
3. A “deterioration” yes, but not “bad”.
Current and quick ratios lower than industry averages may indicate a higher risk of financial distress/default i.e. going concern risk.
They can be regarded as too high – meaning that management is not using current assets as efficiently as competitors in the same industry.
You may find this article useful https://opentuition.com/acca/aa/use-ratios-comparisons-auditing (the download pdf)
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