Shane, Kevin and I stopped by the old “watering hole” for an attitude adjustment

Question

Shane, Kevin and I stopped by the old “watering hole” for an attitude adjustment. Guess what? The conversation turned to work. Here is how the conversation unfolded. Over the past year, good old SVF has realized an increase in our current ratio and a drop in total assets turnover ratio. Conversely, SVF’s sales, quick ratio, and fixed assets turnover ratio have remained constant. We are arguing about what could cause this. What do you think? The second part of the question is this: We will obviously want to know how to correct these downturns. How do we do it?

Explanation / Answer

Here Current Ratio Is increased and Total Asset Turnover ratio has been decreased.

Sales,Quick Ratio and Fixed Asset Turnover ratio have remained constant.

Current Ratio increase shows Increase in Current Assets.

Current Ratio = Current Assets/Current Liabilities

Quick ration = Current Assets - Ending Stock / Curreent Liabilities

Current Assets = Quick Asset + Ending Stock

Here in the current case the Quick Ratio remains same,and current ratio has been increased, which means that wahtever increase in current ratio occured,is only because of increase of Ending Stock,whichultimately increased the Current Assets . It means that the company is manufacturing products but not able to sell them in the market,which ultimately leasds to addtional blockage or delay in realisation of capital invested in Ending Stock.

Total Asset Turnover Ratio = Sales / Net Assets = Sales /(Fixed Asset +Current Assets) ,and ,

Fixed Asset Turnover ratio = Sales/ Fixed Assets

Since Sales is constant and Ending Stock as been increased, therefore the total asset turnover ratio has been dropped and Fixed Asset Turnover ratio remains constant.

So, the reason is increase in Ending Stock.

b. Ending Stock balance may be sold in the market quickly to realize the capital invested in the ending stock.

Proper inventory management system to be implemented to minimize the ending stock.

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