Objective 5

Calculate the acid-test ratio and days’ sales in receivables

(Cash + Short-term investments + Net current receivables) ÷ Total current liabilities

Acid-Test Ratio

• Also called the “quick ratio”

• Stringent measure of liquidity

• Measures entity’s ability to pay its current liabilities immediately

Quick assetsCurrent liabilities

Liquidity Ratios

• Quick ratio (acid test ratio) – if the entity could pay all its current liabilities if they came due immediately– Quick assets - cash, short-term investments,

net current receivables- Lets review S8-12(a)

Solvency Measures — The Short-Term CreditorSolvency Measures — The Short-Term Creditor

Quick assets:Cash $ 250Short-Term Investments 170Accounts receivable (net) 220 Total $640

Current liabilities($380+$160) $540

Acid-test S8-12Acid-test S8-12Acid-test S8-12Acid-test S8-12

2012

Solvency Measures — The Short-Term CreditorSolvency Measures — The Short-Term Creditor

Acid-Test RatioAcid-Test RatioAcid-Test RatioAcid-Test Ratio

Use: To indicate instant debt-paying ability.Use: To indicate instant debt-paying ability.

2012

Quick assets:Cash $ 250Short-term investments 170Accounts receivable (net) 220 Total $640

Current liabilities $540

Quick RatioQuick Ratio 1.191.19

One day’s sales = Net sales ÷ 365 days

Days’ sales in average accounts receivable =Average net accounts receivable ÷ One day’s sales

Days’ Sales in Receivables

Days’ Sales in Receivables

• Also called “collection period”

• How many days does it take to collect the average level of receivables?

• Lets review S8-12(b)

Days ‘ sales in receivablesDays ‘ sales in receivables

S8-12(b)Average Accounts Receivable S8-12(b)Average Accounts Receivable S8-12(b)Average Accounts Receivable S8-12(b)Average Accounts Receivable

Accounts receivable (net):

Beginning of year $ 110 End of year 220 Total $ 330

Average $ 165

Current Year

Solvency Measures — The Short-Term CreditorSolvency Measures — The Short-Term Creditor

Number of Days’ Sales in ReceivablesNumber of Days’ Sales in ReceivablesNumber of Days’ Sales in ReceivablesNumber of Days’ Sales in Receivables

Use: To assess the efficiency in collecting receivables and in the management of credit.

Use: To assess the efficiency in collecting receivables and in the management of credit.

Current Year

Average Accounts Receivables $ 165Net sales on account $2,555 Average daily sales on

on account (sales 365) $ 7

Number of days’ sales in Number of days’ sales in

receivablesreceivables 2424

Sales on Account/ Average Accounts Receivable

It assess the efficiency in collecting receivablesand the ability of management to manage credit.

Lets take a look at S8-12 and compute the Accounts Receivable Turnover

Accounts Receivable Turnover

Accounts Receivable TurnoverAccounts Receivable Turnover

Accounts Receivable Turnover Accounts Receivable Turnover Accounts Receivable Turnover Accounts Receivable Turnover

Net sales on account $2,555 Accounts receivable (net):

Beginning of year $ 110End of year 220 Total $ 330

Average $ 165

Current Year

Solvency Measures — The Short-Term CreditorSolvency Measures — The Short-Term Creditor

Accounts Receivable TurnoverAccounts Receivable TurnoverAccounts Receivable TurnoverAccounts Receivable Turnover

Use: To assess the efficiency in collecting receivables and in the management of credit.

Use: To assess the efficiency in collecting receivables and in the management of credit.

Current Year

Net Sales on account $2,555Acct. Receivable (net):Beginning of year $ 110 End of Year 220 Total $330

Average $165 Accounts Rec. Turnover 15.5Accounts Rec. Turnover 15.5