Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance نسخه متنی

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Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance - نسخه متنی

Daniel L. Gardner

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The Current Ratio

Designed to work in unison with working capital calculations, the current ratio measures to what extent current assets cover current liabilities (current assets/ current liabilities). Much like working capital figures, the result of this calculation is a relative number, the significance of which is dictated by company philosophy and policy. Whereas a conservative company would want a higher ratio, a more aggressive organization would seek to have a ratio that approximates one (one dollar in assets for every dollar in liabilities). Again, the outcome of this ratio will complement the working capital number insomuch as it uses a different methodology to measure the same variable, namely the ability to meet current liabilities with current assets.

Using Y1 as a base figure, Table 13.4 shows that NikoTech's current ratio was 3.5 ($1.059 billion/$303 million). Quantitatively, this figure states that the company can "cover" its current liabilities 3.5 times. Expressed in less abstract terms, for every dollar that NikoTech had in short-term obligations, it had $3.50 in current assets to cover the payments. In Y2, the ratio moved downward, showing that for every dollar in current liabilities, the company had almost three ($2.97) in current assets ($1.212 billion/$407.4 million). For companies like NikoTech that should be seeking a tighter current ratio (or working capital closer to zero), this shift is seen as an improvement. However, it is important to also note that the current ratio decreased even after working capital increased, a phenomenon that puts the current ratio improvement on dubious ground.



Table 13.4: Y1 and Y2 Current Ratio













Y1


Y2


Delta


Current Ratio


3.5


2.97


0.53


The answer to the above paradox lies in the determination of year-to-year line item changes in current assets and liabilities, as well as the ability to interpret the net impact of those changes on their respective sections of the balance sheet. Working capital expanded in Y2 due to an increase in receivables and inventories, a figure that still dominated all calculations even after netting out the effect of the $177 million decrease in cash. Add to this the negligible growth in accounts payable, and the growing gap in working capital is easy to explain.

The current ratio, on the other hand, "improved" for all the wrong reasons. Specifically, the combination of the $177 million reduction in cash, coupled with the meager relative increase in current liabilities of $104.4 million, created the illusion of improving the ratio to 2.97. Had the improvements come by way of reducing inventories and/or receivables, NikoTech's current ratio in Y2 would be a much more encouraging number.

The comparison of working capital with the current ratio emphasizes the need for analysts to not only go through the math but to also interpret what they have calculated. In the NikoTech case, a superficial treatment of working capital and the current ratio may lead one to believe that things are moving in the right direction. However, a more visceral feel for the dynamics of accounting and supply chain tactics would dictate otherwise. Armed with a deeper understanding of supply chain and financial dynamics, the analyst is better prepared to reverse negative trends in the present and make intelligent decisions for the future.

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