Working Capital and Current Ratio in Accounting
Understanding indicators like net current assets (working capital) and current ratio is crucial in accounting. Net current assets reflect the ability to settle current liabilities and the capital required for operational functions. Managing working capital effectively involves factors like stock management, creditor and debtor relationships, and cash flows. The current ratio, calculated as current assets divided by current liabilities, helps assess financial liabilities. Examples and scenarios illustrate how these indicators impact business operations and financial health.
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INDICATORS 11 - 15 GRADE 11 ACCOUNTING
INDICATOR 11: NET CURRENT ASSETS (WORKING CAPITAL) NET CURRENT ASSETS = CURRENT ASSETS CURRENT LIABILITIES LIQUIDITY = ABILITY TO SETTLE CURRENT LIABILITIES CAPITAL IS NEEDED TO PROVIDE FUNDS TO SET UP INFRASTRUCTURE LAND & BUILDINGS, EQUIPMENT, VEHICLES FUNDS TO CONDUCT NORMAL DAY-TO-DAY TRADING OPERATIONS BUY TRADING STOCK TO SELL TO GENERATE A PROFIT ALL CAPITAL NEEDED TO BE PLANNED TO SET UP TRADING OPERATIONS READ EG ABOUT CINDY CELE PG 280
INDICATOR 11: NET CURRENT ASSETS (WORKING CAPITAL) BUYING ON CREDIT OFFERED BY SUPPLIERS TENDS TO REDUCE THE AMOUNT OF WORKING CAPITAL NEEDED CHALLENGE = HAVE TO MEET SUPPLIERS CREDIT TERMS BY: SELLING STOCK & COLLECTING CASH FROM DEBTORS IN A REASONABLE TIME PERIOD. IDEAL SITUATION = SELLING STOCK & COLLECTING CASH BEFORE SHE NEEDS TO PAY THIS REQUIRES LESS WORKING CAPITAL THERE IS A RELATIONSHIP -/- ASPECTS OF BALANCE SHEET & INCOME STATEMENT ORDER UNDER THE CURRENT ASSETS & CURRENT LIABILITIES SHOW TRADING CYCLE THE
INDICATOR 11: NET CURRENT ASSETS (WORKING CAPITAL) STOCK USUALLY PURCHASED ON CREDIT FROM SUPPLIERS SOME STOCK SOLD ON CREDIT TO DEBTORS CREDITORS ARE PAID BACK DEBTORS SETTLE THEIR ACCOUNT & PAY MONEY
INDICATOR 11: NET CURRENT ASSETS (WORKING CAPITAL) TRADING CYCLE IS ONGOING SELDOM SO SIMPLE TO CONTROL WORKING CAPITAL EFFECTIVELY THE RETAILER MUST ENSURE: THERE WOULD BE ENOUGH LIQUID FUNDS (CASH) TO SETTLE CURRENT DEBTS (CREDITORS) STOCK IS SOLD IN A REASONABLE TIME PERIOD DEPENDS ON NATURE OF GOODS CASH IS COLLECTED WITHIN A REASONABLE TIME USUALLY 1 MONTH ANY SURPLUS LIQUID FUNDS NOT NEEDED IMMEDIATELY SHOULD GET INVESTED TO EARN A RETURN READ CINDY CELE S SCENARIO ON PAGE 281
INDICATOR 12: CURRENT RATIO CURRENT RATIO = CURRENT ASSETS : CURRENT LIABILITIES USED TO ASSES LIABILITY FOLLOWING E.G. S 2 BUS HAVE THE SAME NET CURRENT ASSETS BUT CURRENT LIABILITIES AND CURRENT ASSETS ARE DIFFERENT XX STORES YY TRADERS CURRENT ASSETS R200 000 R1 000 000 CURRENT LIABILITIES R100 000 R 900 000 NET CURRENT ASSETS R100 000 R 100 000
INDICATOR 12: CURRENT RATIO THE CURRENT RATIO FOR THE 2 BUS: XX STORES = 200 000 : 100 000 = 2 : 1 YY TRADERS = 1 000 000 : 900 000 = 1.1 : 1 NORM TO AVOID LIQUIDITY SHOULD BE 2 : 1 SELDOM APPLIES ANYMORE AS INVESTMENTS ARE MORE FLEXIBLE A HIGH RATIO COULD ALSO BE A DISADVANTAGE. WHY? COULD MEAN THAT EXCESS FUNDS ARE TIED UP IN CURRENT ASSETS SUCH AS TRADING STOCK AND DEBTORS
INDICATOR 13: ACID TEST RATIO ACID TEST RATIO = (CURRENT ASSETS INVENTORIES) : CURRENT LIABILITIES NOTE: INVENTORIES = Trading stock + consumables stores ACID TEST RATIO = (RECEIVABLES + CASH) : CURRENT LIABILITIES NOTE: RECEIVABLES = Trade debtors & other receivables CASH = Cash & Cash equivalents INTENTION IS TO COMPARE THE ASSETS THAT CAN BE EASILY LIQUIDATED TESTS THE ABILITY TO MEETS IT S CURRENT DEBTS WITHOUT BEING FORCED TO SELL ITS STOCK UNDER PRESSURE FORCED SALE RESULTS IN STOCK SOLD AT LOW PRICE
INDICATOR 13: ACID TEST RATIO FOLLOWING FIGURES ARE OBTAINED FROM THE BALANCE SHEET: CURRENT ASSETS R600 000 INVENTORIES 240 000 TRADE & OTHER RECEIVABLES 300 000 CASH & CASH EQUIVALENTS 60 000 CURRENT LIABILITIES R330 000 TRADE & OTHER PAYABLES R330 000 ACID TEST RATIO = (300 000 + 60 000) : 330 000 = 1.1 : 1
INDICATORS 14 & 15: TURNOVER RATE OF STOCK & PERIOD FOR WHICH ENOUGH STOCK IS ON HAND NEED TO DECIDE ON APPROPRIATE LEVELS OF STOCK FOR YOUR LINE OF BUSINESS AND TO ENSURE THAT STOCK IS SOLD WITHIN A REASONABLE PERIOD OF TIME THE MORE EFFECTIVE BUSINESS CAN TURN OVER STOCK THE MORE EFFECTIVE IT WILL BE IN GENERATING PROFITS THERE IS NO CORRECT OR INCORRECT STOCK TURNOVER RATE. POLICY ADOPTED DEPENDS ON TYPE OF PRODUCT SOLD READ EG OF FF FASHIONS ON PAGE 284 IF A LOT OF WORKING CAPITAL IS TIED UP IN STOCK IT COULD LEAD TO LIQUIDITY PROBLEMS.
INDICATORS 14 & 15: TURNOVER RATE OF STOCK & PERIOD FOR WHICH ENOUGH STOCK IS ON HAND STOCK TURNOVER RATE = Cost of Sales average Stock NOTE: Average stock = (Opening stock + Closing stock)/2 REPRESENTS THE NUMBER OF TIMES STOCK IS REPLACED DURING THE YEAR EXAMPLE ON PAGE 284: AVERAGE STOCK = (150 000 + 90 000)/2 STOCK TURNOVER RATE = R480 000/R120 000 = 4 TIMES
INDICATORS 14 & 15: TURNOVER RATE OF STOCK & PERIOD FOR WHICH ENOUGH STOCK IS ON HAND PERIOD FOR WHICH ENOUGH STOCK IS ON HAND = Average Stock x 365 Cost of Sales 1 NOTE: Trading stock may be Average stock or Closing stock depending on circumstances ESTIMATE HOW LONG IT WILL TAKE TO SELL THE STOCK NB!! ANSWER IS EITHER IN DAYS OR MONTHS IF MONTHS THEN X 12/1 PERIOD = R120 000 X 365 = 91 DAYS R480 000 1
