Chapter Two - Wiley
Chapter Two - Wiley
Chapter Two - Wiley
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8956d_ch02_074 7/21/03 7:00 AM Page 74 mac76 mac76:385_reb:<br />
74 CHAPTER 2 A Further Look at Financial Statements<br />
We can use these measures to supplement the current ratio and debt to total<br />
assets ratio, to evaluate Best Buy’s liquidity and solvency. Best Buy’s current<br />
cash debt coverage ratio of .36 is slightly less than the recommended minimum<br />
level of .40, suggesting that its liquidity is adequate. On the other hand, Circuit<br />
City’s value of .12 is less than the recommended level. Recall, however, that Circuit<br />
City’s current ratio was quite high. The conflicting results of these two measures<br />
suggest that further evaluation of Circuit City’s liquidity is warranted. For<br />
example, it is possible that Circuit City’s current ratio was so high because it had<br />
accumulated obsolete inventory. This would result in a high current ratio, even<br />
though the inventory was not very liquid.<br />
Best Buy’s cash debt coverage ratio of .33 is well in excess of the recommended<br />
minimum level of .2, suggesting that its solvency is acceptable. Again,<br />
Circuit City’s value falls short of the recommended level, leaving its solvency in<br />
doubt. We will investigate other measures of liquidity and solvency in later<br />
chapters.<br />
DECISION TOOLKIT<br />
Decision Checkpoints Info Needed for Decision Tool to Use for Decision How to Evaluate Results<br />
Can the company meet its<br />
near-term obligations?<br />
Current liabilities and cash provided<br />
by operating activities<br />
Current<br />
cash debt<br />
<br />
coverage<br />
ratio<br />
Cash provided<br />
by operations<br />
<br />
Average current<br />
liabilities<br />
A higher ratio indicates liquidity,<br />
that the company is generating<br />
cash sufficient to meet its nearterm<br />
needs.<br />
Can the company meet its<br />
long-term obligations?<br />
Total liabilities and cash provided<br />
by operating activities<br />
Cash debt<br />
coverage<br />
ratio<br />
Cash provided<br />
by operations<br />
<br />
Average total<br />
liabilities<br />
A higher ratio indicates solvency,<br />
that the company is generating<br />
cash sufficient to meet<br />
its long-term needs.<br />
BEFORE YOU GO ON . . .<br />
Review It<br />
1. What information does the statement of cash flows provide that is not available<br />
in an income statement or a balance sheet?<br />
2. What does the current cash debt coverage ratio measure?<br />
What does the cash debt coverage ratio measure?<br />
■✓<br />
THE<br />
NAVIGATOR<br />
Using the Decision Toolkit<br />
In this chapter we have evaluated a home electronics gaint, Best Buy. Tweeter Home<br />
Entertainment sells consumer electronics products from 154 stores on the East Coast<br />
under various names. It specializes in products with high-end features. A simplified<br />
balance sheet and income statement for Tweeter Home Entertainment are presented<br />
in Illustrations 2-21 and 2-22. Additional information: Tweeter’s cash provided by
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