Cash flow management You are attending a meeting at your new employer, a small wholesaler of home gymnasium equipment. One of the presentations includes a PowerPoint showing the company’s current ratio had increased from 1.5:1 to 2.6:1 over the last three years and the quick ratio has increased from 0.6:1 to 1.3:1. The presenter starts talking about the importance of cash flow and liquidity and concludes how delighted they are with the improvements in these ratios and, in particular, the fact that the current ratio is now 2.6:1, which he considers really high. He admits there was concern about the quick ratio three years ago but it has increased significantly to be at a very comfortable level.

On the other hand, the manager refers to the fact that the company’s cash flow cycle is starting to extend, moving from 71 days to 83 days to 101 days across the three years. He notes that this is ‘out of control’, as the accounts payable have cut the repayment period from 30 days to 14 days. Days in inventory have increased both because of increased competition and because ‘our customers get very upset if we are out of stock on any item so we have increased inventory on hand’. Finally, the manager says ‘while we have kept our good faith with our customers by giving them 60 days to pay their invoices, some are taking even longer.

Eventually they all pay so we do not want to lose these customers by changing their terms.’

Required:

1 What do you suggest is the reason for the improved current and quick ratios? What implications does it have for liquidity?

2 What is the problem with the increased cash flow cycle?

3 What can the company do to decrease the cash flow cycle and what will be the benefits and drawbacks of doing this?