4Q- 70 An analyst gathered the following information about a company and the industry: Liquidity measure Company Industry Quick ratio 0.7 1.3 Current ratio 1.1 1.7 Days sales outstanding 38.5 30.2 Days payables outstanding 28.4 22 Based only on the data above, the measure that should most concern the analyst regarding the company’s working capital management is the: A. quick ratio. B. current ratio. C. days sales outstanding. D. days payables outstanding. --------------------------------------------------- my guess is A. 0.7/1.3 <1.1/1.7. not sure
A. the quick ratio
why? acctually working capital = CA-CL, in below case, which is more concern: Liquidity measure Company Industry Quick ratio ----------0.7 --1.3 Current ratio---------0.91–1.7
Days of sales or payables outstanding should really be compared with the industry to see if there is something wrong (if sales is greater maybe your inventory is not selling because it is obsolete, if it sales too fast maybe your price is too low and you miss on some opportunities to charge a higher price; if payables are greater than industry average maybe your suppliers become anxious about it, if you’re paying too fast again you miss on opportunities to do something productive with your money). Current ratio going down is not necessarily a bad sign, maybe you’re rolling over your inventory faster (not the case really here because your days of sale outstanding is going up). The quick ratio excludes inventory in the numerator, so CA-Inventory going down that fast, that’s a sign of short-term liquidity problems. My $0.02.
Guess who’s knocking at your door if you pay only 70% of your current liabilities?
In the second case, you are in deep trouble; both ratios are a very bad sign. I cannot decide which one is worst.
make sense. thanks a lot.
the answer/feedback pdf says: “The company’s days sales outstanding is considerably higher than the industry’s, which means the company is slower in collecting its receivables than the average firm. This is a concern because the longer receivables are outstanding, the greater the probability they will not be collected and will have to be charged off, thereby adversely affecting earnings.” I’m not sure how they reason that Day Sales Outstanding is of greater concern than the other options. is this basically a “b/s” Bullshhh question?!?!?!?