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

The Quick Ratio (Acid Test)

Given that liquidity is a fundamental component of working capital measurement, the quick ratio, or acid test, must be a part of any comprehensive analysis. Designed to eliminate the inherently non-liquid nature of inventories, the ratio recalculates the current ratio, less the value of inventories. This enhanced calculation allows a more realistic view of how well a company can cover current liabilities, removing inventory from the equation entirely.

As displayed in Table 13.5, NikoTech's acid test has taken a turn for the worse. In Y1, the company could cover short-term obligations 1.91 times ($579 million/$303 million), but in Y2 the ratio dropped to 1.35 ($552 million/$407.4 million). When the value of inventories is removed, the Y2 quick ratio shows that the company can cover every dollar in current liabilities with $1.35. This is a rather stark comparison with the original working capital and current ratio results, numbers that now seem to hide an increasingly obvious problem with inventories.

Table 13.5: Y1 and Y2 Acid Test

Without question, NikoTech must remedy its inventory and receivables problems by implementing the aforementioned tactics and policies to improve its working capital position. An additional measure that the company may consider involves internal financial policies that promote conscientious asset management. Similar to the penalty levied by companies when they write off bad receivables or obsolete inventory, it may be prudent for NikoTech to institute an internal interest charge on working capital amounts that are outside corporate parameters.

If management dictates a working capital ceiling for each plant, any plant that exceeds its amount would be charged interest on the underutilized assets, much like interest on a loan. This "interest charge" would appear on the income statement as an expense, again detracting from net income. Coupled with the policy on write-offs, this additional mechanism would encourage supply chain managers to actively manage their assets and liabilities on a daily basis.

During the analysis of the cash-to-cash cycle, it was suggested that the days payable outstanding figure should be reduced, with the net impact (upon improving the asset side of the equation) being positive. This statement has important ramifications for the working capital equation because if current liabilities are reduced without a corresponding improvement from current assets, the net outcome for working capital will be worse. Understanding that the goal of organizations is to reduce working capital (better use of assets), a decrease in current liabilities would widen the gap in working capital. The relationship between asset management and improvement of cycle time and its impact, in this case on working capital, is but another example of how supply chain execution tangibly impacts the financial performance of a company.