Account Receivables Liquidity Measures

a) AR Turnover (ART) = net sales on credit average AR

Notes receivables from normal sales should be included when computing ART
Include only credit sales because cash sales do not create receivable
If the proportion of cash sales to total sales is stable than year to year, comparison

of changes in the ART ratio are reliable

To determine average AR is to add beginning (b/d) and ending (c/d) AR and

divided by 2
b) Days sales in receivable / collection period / days sales outstanding
= average AR (credit sales 360@365 days)

The ART ratio measured the speed of collection and is useful for comparison

purpose
This comparison is made by converting the turnover ratio into days of sales in

receivable
It measured the number of days it takes on average to collect account receivable
based on the year end balance in AR

Interpretation of AR Liquidity Measures

ART and collection period are usefully compare with industry average or credit term

given by company
When the collection period is compared with the term of sales allowed by the

company, we can access the extent of customer paying on time

For example, if credit terms of sales are 40 days, than average collection period is 75

days, shows one or more of the following conditions:

Poor collection efforts
Delay in customer payment
Customer in financial distress
How to reduce the collection period:
Discount allowed within the credit period
Called customer to remind them to avoid become bad debt

Inventory Liquidity Measures

a) Inventory Turnover (IT) = cogs@cos average inventory
Inventories are investment made for purpose of obtaining return through sales to
customer

If inventory is not enough, sales volume decline below average level

Excessive inventory expose a company to storage cost, insurance, tax and others
IT ratio measured the average rate of speed at which inventories moves through

and out of a company

Average inventory is to add beginning (b/d) and ending (c/d) inventory and

divided by 2
b) Days sales in inventory = (ending inventory@c/d cogs@cos) x 360@365 days
Important in assessing a company purchasing and production policy
This ratio tells us the number of days required to sale ending inventory
Intrepretation Inventory Liquidity Measures

IT offer measure the quality and liquidity of the inventory components of current asset
When IT decrease over time or less than the industry average, it suggest slow moving

inventory item or weak demand

By effective inventory management will able to increase IT

Current Liability Liquidity Measures is important in analysis working capital and

current ratio
a) Days purchase in Account Payable = purchase average AP
A measured of the extent to which company is the average payable days

outstanding
Average payable days outstanding provides indication of the average time the

company takes in paying its obligation to the supplier

The longer the payment period, the higher the use of supplier capital
Account payable turnover ratio indicates the speed at which a company pays for
purchase on credit