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John Moffat.
John Moffat.-
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dennissherpa101
- Topics: 43
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Sir if the inventory holding period is high and the receivables collection period is high that would giver a higher inventory and receivables balance but this would also mean cash is coming slower which is compromising liquidity. But if the CA is high then woking capital is also high and then current ratio is also higher which means it has better liquidity. Sir I am confused to which is right and how do I find the logic behind it. . I know if alot of fund is tied in WC lower profitability but higher liquidity. but still it could be higher due to higher holding days stilll this mean lower liquidity
John Moffat
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Liquidity is looking at whether or not the company is able to pay its liabilities in the short term.
The most common measure is the current ratio, and provided it is greater than 1 then they should be able to pay their bills. However although cash is obviously immediately available, it will take longer to get the cash from receivables but hopefully the company will be taking as much credit from payables as it is giving to receivables. However, inventory takes longer to turn into cash because it first needs to be sold and then it becomes a receivable. That is why the acid-test (quick) ratio is also used as a measure of liquidity.
dennissherpa101
- Topics: 43
- Replies: 56
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if the operating cycle is longer does this mean that liquidity is high even though cash is commming late?
John Moffat
- Topics: 57
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No. A longer operating cycle suggests that the liquidity is lower.
dennissherpa101
- Topics: 43
- Replies: 56
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But if longer operating cycle sir inventory is higher receivables is higher and working capital is higher and if working capital is higher liquidity is also higher. I am having this confusion for quite some time now sir I dont quite get where I am getting wrong.
dennissherpa101
- Topics: 43
- Replies: 56
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can you kindly make this clear to me sir
John Moffat
- Topics: 57
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There is no single measure of liquidity – there are a range of things to look at.
Certainly the most important measure is the current ratio – that current assets are more than the current liabilities.
However at the same time it is important that the company takes as much credit from suppliers as they give to their customers. It is obviously not sensible to allow customers to take 2 months to pay if we are paying our suppliers within 1 months.
dennissherpa101
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