Analysis of the Operation and Financial Condition of the Enterprise

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Analysis of the Operation and Financial Condition of the Enterpriseliquidity=(current) ratioCurrent liabilities(4.1.)Current liabilities are debts with the repayment term not exceeding one year. Currentliabilities are made up of such items of balance sheet liabilities like bank loans, bills ofexchange payable, trade accounts payable, customers’ advances, taxation payable, salariespayable etc.Current or short-term assets are assets that are used, consumed or sold within asingle reporting period. These include cash assets, short-term financial investments,accounts receivable and stock of raw materials for production of goods.The absolute or overall liquidity ratio (current ratio) describes the capacity of anenterprise to repay its short-term debts. The higher this ratio is the higher the payingcapacity (solvency) of an enterprise estimated. Changes in this ratio must be looked at in adynamic perspective. In accordance with the generally accepted international standards it isbelieved that this ratio must be within the limits of 1 and 2 (sometimes 3). The lower limitis preset as 1, because the amount of current assets in any enterprise must be at least ashigh as to be able to meet its current liabilities, otherwise the enterprise may facedifficulties in settlement of its short-term debts. The excess of current assets over currentdebts of above two or three times also is not desirable as this may be a proof or anirrational capital structure – the enterprise has invested too much in the current asset itemsor has insufficiently used its short-term loans.The overall liquidity ratio (current ratio) can be raised in two ways: either byincreasing the value of some current asset items or reducing the value of its short-termdebts.If stock and prepaid expenses are deducted from the current assets, it is possibleto calculate the quick ratio which is expressed by dividing the liquid assets by currentliabilities:Quick ratio=Current assets – (Stock + Prepaid expenses)Current liabilities(4.2)There can be other formulas found in the sources of reference according to which the quickratio is calculated, although the mathematical outcome remains the same:Quick ratio =Cash + Short-term securities + accounts receivableCurrent liabilities(4.3.)This ratio shows the asset capital involved in the enterprise operations which isestimated as the difference between the amounts of current assets and current liabilities70
Analysis of the Operation and Financial Condition of the Enterprise(any increase in the capital shows the improvement of the company financial status, or juston the contrary – worsening of the situation). This ratio also describes the share of currentliabilities that can be repaid not only in cash, but also from expected earnings from anyworks performed, goods dispatched and services provided.The reference level of the ratio is 1, because then an enterprise is in a realposition of meeting its current liabilities, it can fully settle its debts with the creditorswithout stopping its operations. Overly high quick ratio is not a sign of good businessperformance either as this would mean that there is too much cash accumulated in till andon the bank accounts. Too low level of the ratio could be related to the fact that there iseither too much stock in the enterprise or that there are difficulties in selling this stock.In the majority of cases the most secure assessment of liquidity is by the amountof cash assets at the disposal of an enterprise. This value is called the absolute liquidityratio and estimated as the relationship between cash and current liabilities:Absolute liquidityratio=Cash in till and at bankCurrent liabilities(4.4.)If there are any short-term securities at the disposal of an enterprise, these shouldalso be added to the amount of cash assets, because they are either already expressed interms of cash or are easily convertible into cash. In this case the absolute liquidity ratio iscalculated by the following equation:Absolute Cash + Short-term securitiesliquidity ratio=(4.5.)Current liabilitiesThe higher the amount of current assets is the larger the probability or repaymentof the short-term debts from the existing assets. It is clear though that their amount willdepend on the area of operations of an enterprise. It is generally accepted that, if therelation between current assets and current liabilities is lower than 2:1, an enterprise is notin a position of meeting its liabilities in due time and amount. An excess of current assetsover current liabilities several times indicates a considerable amount of spare resourceseither created from its own assets or by insufficiently using its short-term credits (bankloans and trade credits). Form the point of view of efficiency of performance inaccumulation of stock the allocation of assts for financing of debtors is considered to be anunprofessional use of assets.By analysing liquidity of an enterprise large attention needs to be devoted toidentification of Net current assets or the Current capital (Working capital).Net current assets = Current assets – Current liabilities (4.6)Net current assets are required for the maintenance of financial stability of anenterprise, because the excess of current assets over current liabilities evidences that anenterprise is not only in a position of meeting its short-term debts, but it also has thefinancial resources available for expansion of business in the future.71
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