Numerous technical adjustments can be made to short-term liquidity ratios, such
ID: 2728161 • Letter: N
Question
Numerous technical adjustments can be made to short-term liquidity ratios, such as adjusting accounts receivable turnover for cash sales, accounting for LIFO liquidation in computing days in inventory, and replacing cost of goods sold with purchases when calculating accounts payable turnover. 2.5 pages plus apa bib response is required.) a. Discuss one (1) determinant of a short-term liquidity ratio. b. Discuss when an analyst should make technical adjustments. c. Discuss four (4) instances when such adjustments would not be warranted.
Explanation / Answer
Short term liquidity ratio tells us that how quickly with in no time a firm can pay off its current liabilities. It is basically determined by dividing Current Assets to Current liabilities, Current assets constitutes of Cash, equivalent of cash, Account receivables, Inventory ( if you pay attention closely here, you can make a guess all these items can be quickly converted into cash whenever needed, and current liabilities comprises of any short term payments such as overdrafts, Accounts payables etc. so the main essence of this short term liquidity ratio is to know how quickly a company can get rid off with its short term liabilities, there is another real short term liquidity ratio that is quick ratio, wherein we just remove the inventory from current assets and the arrived value is divided by current liabilities, here again the main essence is how quickly one can pay its short term liabilities. Inventories are taken off because there is an assumption that inventories some time can take longer time selling them or converting them into cash.
Technical adjustments can be made in short term liquidity ratio, It is just misuse accounting concepts and nothing else, it can be made when the ratio calculated is not matching as per the industry, when there is the cash equivalents in the business, but it might take some longer period to convert into cash, there might be over stock of inventory to gain the benefit of fluctuations in the raw material prices, there might be other reasons as well, it is just to cover the short term liquidity capabilities of the firm, though it can not guarantee it will do so when needs arrive. Technical adjustments such as changing from LIFO to FIFO can be made when there is huge possibility of an increase in the price of the raw material, you would like to count your inventory on the increased price. You can make the changes here also when you see the most of the inventories are held up in work in progress. You would like to show it fifo method to increase the value inventories. In calculating account receivable, companies can include cash and credits both and hence can change this ratio, the same they can do with Accounts payable turnover ratio while mixing the credit purchase and cash purchase. There are some instances when these technical adjustments can not be warranted those instances are like, when there is huge fluctuations in the price of inventories, another is where SAP is implemented and you need to disclose cash and credit sales, another instances where in you need to disclose cash and credit purchases, another is you need to properly disclose the accrued liabilities, these are the some instances wherein these technical adjustment will not be guaranteed.
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