Metrics (Liquidity) and a Review of Accounting in 2006 (#28)

In this episode, we review the key accounting events during the past year, and also discuss the key metrics for liquidity. Key points discussed concerning accounting events are:

  • Enron and Worldcom jail terms were handed down.

  • There were a series of stock option manipulation frauds.

  • The SEC issued new compensation disclosure rules.

  • FIN 46 was issued, involving off-balance sheet reporting requirements.

  • Issues with the existing lease and pension accounting standards were discussed.

  • The industry dealt with ongoing complaints about the requirements of Sarbanes-Oxley section 404, pertaining to systems of control.

Key points relating to the metrics for liquidity are:

  • The current ratio is not a useful indicator of liquidity, since it includes inventory, which is not liquid.

  • The quick ratio is better, since it removes inventory from the calculation.

  • A comparison of sales to assets can be plotted on a trend line; the proportion should be about the same over time.

  • The days of working capital ratio indicates the amount of working capital needed to support one day of sales.

  • The accounts receivable collection period indicates the average number of days during which an invoice is outstanding, before it is collected.

  • A comparison of sales to inventory can be plotted on a trend line, to indicate the ongoing investment level of a business in inventory.

  • The accounts payable days measurement can be plotted on a trend line to highlight any changes in payables duration.

  • The risky assets conversion ratio shows the percentage of low-value assets on a company’s balance sheet.

Related Courses

Business Ratios Guidebook