SHORT TERM LIQUIDITY

Importance of short-term Liquidity

• Definition: The ability to cover short-term debt

• Interests shareholders & creditors• Taking advantage of market

opportunities• Static vs. dynamic view• Reverse relation to Return

LIQUIDITY RATIOS

Α) CURRENT RATIO

sLiabilitieCurrent

AssetsCurrentRatioCurrent

Current Ratio value

• Normal spread 1-2

• average 1,5

• Current ratio relates to:sectorBusiness life cycle Business organizationAccounting methods

Issues in current ratio use

• Wide usage

• Assumption of business closure

• Mix of historical & current prices

• Affected from assets valuation

Accounts that require attention

• Securities:valuationMarket value (day of analysis)

• Accounts receivables:Bad debts – provisions

• Inventories: Valuation (LIFO v. FIFO)devalued – slow moving

Ways of analyzing the Current Ratio

• Times-series

• Cross sectional – related to sector

• Common size statement for the Current Ratio’s components

Matters arising

• Use of LIFO with inflation

• Effects of economic cycle

• Tampering the ratio:postponement or acceleration of

transactions that affect on the ratio

Current assets over-valuedDevaluation of liabilitiesDisposal of fixed assetsSubstitution of short-term debt with

long-term debt

Β) QUICK RATIO

• More conservative measure of liquidity

• spread 0,7 – 1,2

• average 0,9

advancescashsliabilitiecurrent

prepaidsinventorieassetscurrentQR

.exp

Quick ratio: Does not include

• InventoriesDifficulties in liquidation Subjectivity in valuation (market price vs.

purchase value)

• Receivables & liabilities that do not require cash inflow/outflow Prepaid expenses & advances to suppliersAdvances from customers & deferred income

C) ACID RATIO

• The most strict liquidity measure

AdvancesCashsLiabilitieCurrent

SecuritiesCashAR

D) Defensive Interval

ExpensesDaily

sReceivableSecuritiesCashDI

Daily Expenses:

(Yearly expenses-depreciation) / 365

Ε) CF(OA) / Current Liabilities

• Dynamic liquidity test

• Shows financial strength

• average 0,40

TURNOVER RATIOS (Activity Measures)

• Calculate the time period for the liquidation of an account

• Turnover ratios: linked to liquidityAffect return

1) Inventory Turnover Ratio

r)(times/yeaInventoryAverage

Sales ofCost I TR

IT

365InventoryinDays

Operational target:

• Increase of Inventory Turnover• Reduce inventory held (δέσμευση

πόρων)Attention:• Seasonal inventories • valuation (LIFO under inflation)• Increase of IT by reducing inventory

2) Receivables Turnover Ratio

r)(times/yeasReceivable Average

credit)(on SalesRTR

RT

365Receivable Accountsin Days

Receivables from commercial activities only

(customers, notes receivables, etc)

Operational target:

• Increase of RT, with increase in sales

Attention:

• Sales on cash or on credit

• Seasonal receivables

• Provision for bad debts

• Add discounted notes receivables

• In relation to credit policy

Days accounts receivables due

client total 1-30 31-60 61-90 > 90

Χ 120 10 20 30 50

Ψ 150 - 30 50 70

Amount due in days

3) Accounts Payable Turnover Ratio

r)(times/yeaPayableAverage

PurchasesPTR

STR

365SuppliersinDays

Attention: suppliers plus notes payable from commercial activities

Operational target:

• Low PTR – increase in days accounts payable due (without price increase)

Attention:• Calculating purchases:

Cost of sales + inventory beginning – inventory end

• Seasonality of Accounts Payable

Inventory & Cash conversion cycle

• Operating cycle or Inventory conversion cycle = (Days in Inventory + Days in Accounts Receivable)

• Trading cycle or Net cash conversion cycle = (Days in Inventory + Days in Accounts Receivable – Days in accounts payable)

Operational Target:

• Decrease in Inventory conversion cycle

• Increase in accounts payable credit period

• Decrease in Net cash conversion cycle