Controllership HW 6

For question # 4 “hints” pages 360-361 (The Controller’s Function by Steven Bragg)

Measures of Growth

This information provides methods to determine a company's growth.

▪ Percent increase in sales. This measure can be compared to the size of the market to determine if the company has changed its percentage share of the market. It can also be reviewed for sales changes based on volume or price increases.

▪ Percent increase in net income. This measure is heavily used, but does not account for asset or equity usage; nor does it consider the impact of long-term research and development or other capital investment decisions.

▪ Percent increase in earnings per share. This measure indicates the avoidance of stock dilution, the use of debt, the use of retained earnings, or the acquisition of a company with a lower price/earnings ratio.

Liquidity Measures

These ratios measure the firm's ability to meet short-term obligations.  Exhibit 20.3  shows calculations of liquidity measures.

▪ Current ratio. This is one of the most widely used ratios, particularly among credit people, to assess liquidity. It is calculated by dividing the total current assets by the total current liabilities. A ratio of 2 to 1 has long been considered as reflecting a satisfactory condition. When evaluating this ratio, the turnover rate of receivables and inventory should also be considered since low turnover rates actually contribute to an enhanced current ratio.

▪ Quick ratio. This is a supplement to the current ratio. It is defined as the relationship of cash, receivables, and investments to the current liabilities. This ratio excludes inventory on the assumption that inventory takes time to liquidate and so is not indicative of the firm's ability to meet its current obligations. A ratio of 1 to 1 is considered acceptable.

Exhibit 20.3Liquidity Measures

▪ Cash ratio. This is the most conservative measure of a company's ability to pay off its liabilities in the short term. It excludes the company's potential liquidation of any accounts receivable or inventory in order to meet that goal.

▪ Working capital to debt ratio. This ratio can be used to see if a company could pay off its debt by liquidating its working capital. The measure is used only in cases where a debt must be paid off at once because eliminating a large amount of working capital makes it impossible to run a business and likely will lead to its dissolution.

▪ Days of working capital. This ratio, when tracked on a trend line, is a good indicator of changes in the efficient use of working capital. A low number of days of working capital indicates a highly efficient use of working capital. However, a seasonal business may yield a highly variable metric, depending upon the time of year.

▪ Expense coverage days. This calculation yields the number of days that a company can cover its ongoing expenditures with existing liquid assets. The information is most useful for situations where the incoming cash flow is likely to be shut off, and management needs to know how long the company can continue to operate without an additional cash infusion.

▪ Risky asset conversion ratio. This measurement shows the proportion of a company's recorded assets that are unlikely to be easily converted into cash. This information is useful to lenders or acquirers because they need to know the underlying value of the company in which they are making an investment.

▪ Liquidity index. This measures the number of days it would take to convert accounts receivable and inventory into cash and is useful in determining a company's ability to generate sufficient cash to meet upcoming liabilities.

▪ Altman's Z-score bankruptcy prediction formula. This bankruptcy prediction mechanism combines five common business ratios, using a weighting system that was statistically calculated by Dr. Edward Altman to determine the likelihood of a company going bankrupt at some point in the future.