Previously, the current ratio (current assets divided by current liabilities) and the amount of working capital (current assets minus current liabilities) were discussed. Are there additional vital signs that relate to current liabilities that should be analyzed when looking at an organization? Should decision makers be aware of any specific ratios or amounts in connection with current liabilities that provide especially insightful information about a company’s financial health and operations? Answer: In studying current liabilities, the number of days a business takes to pay its accounts payable is a figure of interest. If a business begins to struggle, the time of payment tends to lengthen because of the difficulty in generating sufficient cash amounts. Therefore, an unexpected jump in this number is often one of the first signs of financial problems and warrants concern. To determine the age of accounts payable (or the number of days in accounts payable), the amount of inventory purchased during the year is first calculated: cost of goods sold = beginning inventory + purchases – ending inventory, Thus, purchases = cost of goods sold – beginning inventory + ending inventory. Using this purchases figure, the number of days that a company takes to pay its accounts payable on the average can be found. Either the average accounts payable for the year can be used below or just the ending balance.
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The average purchases amount made each day during 2008 by this company was nearly $86 million: purchases/365$31.382/365 = $85.978 million. The average age of ending accounts payable for Safeway at this time is between twenty-eight and twentynine days: accounts payable/average daily purchases$2.449 billion/$85.978 million = 28.48 days. To evaluate that number, a decision maker would need to compare it to previous time periods, the typical payment terms for a business in that industry, and comparable figures from other similar corporations. Interestingly, the same computation for the previous year (2007) showed that Safeway was taking over thirty-four days to pay off its accounts payable during that period.
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