Chapter 5, Slide #4 Short-Term Liquidity Risk Tools: Current ratio = current assets/current liabilities Quick ratio = cash+mktble securities+receivables current liabilities
Chapter 5, Slide #5 Short-Term Liquidity Risk Operating Cash Flow to Current Liabilities = Cash Flow from Operations Average Current Liabilities Working Capital Activity Ratios –Accounts Receivable Turnover –Inventory Turnover –Accounts Payable Turnover
Chapter 5, Slide #6 Short-Term Liquidity Risk Days of Working Capital Financing Needed: Days Inventory Held + Days A/R Outstanding less Days A/P Outstanding = Days of Working Capital Financing Needed. Revenues to Cash Ratio: Revenues Average Cash Balance
Chapter 5, Slide #7 Long-Term Solvency Risk Debt Ratios Long-term debt = Long-term debt L/T debt + S/H Equity Debt/Equity Ratio = L/T debt S/H Equity Liabilities to Assets Ratio = Total Liabilities Total Assets
Chapter 5, Slide #8 Long-Term Liquidity Risk Interest coverage ratio: Net income + interest exp + income tax exp + minority interest in earnings Interest expense Operating cash flow to total liabilities: Cash flow from operations Avg total liabilities
Chapter 5, Slide #9 Credit Risk Circumstances –Ongoing operations? –Operating problems, emerging businesses, investment in intangibles – all riskier... Cash Flows –Can the firm generate the cash to repay? –A/R or Inventories growing faster than sales? –A/P increase > increase in inventories? –Consistent negative CFOA?
Chapter 5, Slide #10 Credit Risk (cont.) Cash Flows (cont.) –Capital expenditures > CFOA? –Decline in capital expenditures? –Sales of mktble securities > purchases? –Shift from L/T to S/T borrowing? –Reduced dividend payments?
Chapter 5, Slide #12 Credit Risk (cont.) Contingencies Character of Management Conditions Debt covenants
Chapter 5, Slide #13 Bankruptcy Risk Altman’s Z-score –Z less than 1.81 indicates high probability –Z greater than 3.00 indicates low probability Error types –Type I: class firm as nonrisk, ultimately does go bankrupt –Type II: class as bankrupt, remains viable
Chapter 5, Slide #14 Bankruptcy Prediction Investment Factors –Relative Liquidity of Assets cash/total assets current assets/total assets net working capital/total assets or fixed assets/total assets –Rate of Asset Turnover total assets turnover accounts receivable turnover inventory turnover
Chapter 5, Slide #15 Bankruptcy Prediction Financing Factors –Relative Proportion of Debt total liabilities/total assets total liabilities/shareholders’ equity –Relative Proportion of Short-term Debt current liabilities/total assets
Chapter 5, Slide #16 Operating Factors –Relative profitability net income/assets income before interest and taxes/assets net income/sales cash flows from operations/assets –Variability of operations cyclical sales patterns Bankruptcy Prediction