fra lecture 9

8/9/2019 FRA Lecture 9

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FINANCIALREPORTING AND

ANALYSISLecture: 15

Lecturer: HAROON IQBAL


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OPERATING CYCLEEfciency o opertin! cyc"e#proce$$: It is

determined by activity ratios, keeping in view teconversion process, wic is as !o""ows:#

Opertin! Cyc"e%In&entory $"e 'y$ (&er!e)*Recei&+"e Co""ection 'y$ (&er!e),

$e sorter te operating cyc"e, te iger te %ua"ity

o! current assets and te greater te e&ciency o!

management'-n!in! Account$ Recei&+"e: $e business

o(ers cas discount to encourage ear"y payment or)!actors* Receivab"es i'e' se""ing Receivab"es to a

+nancia" institution !actor-'

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$e operating cyc"e !or a company is te time periodbetween te ac%uisition o! goods and te +na" cas

rea"i1ation resu"ting !rom sa"es and subse%uentco""ections'

3or e4amp"e, a !ood store purcases inventory andten se""s te inventory !or cas' $e re"ative"y sorttime tat te inventory remains an asset o! te !oodstore represents a very sort operating cyc"e'

In anoter e4amp"e, a car manu!acturer purcasesmateria"s and ten uses Labour and overead toconvert tese materia"s into a +nised car' A dea"er

buys te car on credit and ten pays temanu!acturer' /ompared to te !ood store, te carmanu!acturer as a muc "onger operating cyc"e, but

it is sti"" "ess tan a year' On"y a !ew businesses avean operating cyc"e "onger tan a year'

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/as is a medium o! e4cange tat a bank wi""accept !or deposit and a creditor wi"" accept !or

payment' $o be c"assi+ed as a current asset, casmust be !ree !rom any restrictions tat wou"dprevent its deposit or use to pay creditors c"assi+edas current' I! restricted !or speci+c#sort term

creditors, many +rms sti"" c"assi!y tis cas undercurrent assets, but tey disc"ose te restrictions'

/as restricted !or sort#term creditors sou"d bee"iminated a"ong wit te re"ated amount o! sort#term debt wen determining te sort term debt#paying abi"ity' /as sou"d be avai"ab"e to paygenera" sort#term creditors to be considered aspart o! te +rm6s sort#term debt#paying abi"ity'

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-r/et+"e $ecuritie$$e business entity as varying cas needs trougout

te year' Because an in!erred cost arises !rom keepingmoney avai"ab"e, management does not want to keep a""

o! te entity6s cas need in te !orm o! cas troug teyear' $e avai"ab"e a"ternative turns some o! te casinto productive use troug sort#term investmentsmarketab"e securities- wic can be converted into casas te need arises'

$o %ua"i!y as a marketab"e security, te investment mustbe readi"y marketab"e, and it must be te intent o!management to convert te investment to cas witinte operating cyc"e or one year, wicever is "onger' $ekey e"ement o! tis test is manageria" intent'

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It is to management advantage to sow investments undermarketab"e securities, instead o! "ong#term investments,because tis c"assi+cation improves te "i%uidityappearance o! te +rm' 9en te same securities arecarried as marketab"e securities year a!ter year, tey are"ike"y e"d !or a business purpose'

3or e4amp"e, te oter company may be a maor supp"ieror customer o! te +rm being ana"y1ed' $e +rm wou"d notwant to se"" tese securities to pay sort#term creditors'

$ere!ore, to be conservative, it is better to rec"assi!y temas investments !or ana"ysis purposes'

Investments c"assi+ed as marketab"e securities sou"d betemporary' ;4amp"es o! marketab"e securities inc"udetreasury bi""s, sort#term notes o! corporations, governmentbonds, corporate bonds, pre!erred stock, and commonstock' Investments in pre!erred stock and common stockare re!erred to as marketab"e e%uity securities'


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In&entorie$Inventor is o!ten te most signi+cant asset in determining te sort#

term debt paying abi"ity o! an entity' O!ten te inventory account ismore tan a"! o! te tota" current assets' Because o! tesigni+cance o! inventories, a specia" e(ort sou"d be made to

ana"y1e proper"y tis important area'$o be c"assi+ed as inventory, te asset sou"d be !or sa"e in te

ordinary course o! business, or used or consumed in te productiono! goods' A trading concern purcases mercandise in a !orm to se""to customers' Inventories o! a trading concern, weter wo"esa"eor retai", usua""y appear in one inventory account mercandiseinventory-' A manu!acturing concern produces goods to be so"d'Inventories o! a manu!acturing concern are norma""y c"assi+ed intree distinct inventory accounts, inventory avai"ab"e to use inproduction raw materia"s-, Inventory in production work inprocess-, and inventory comp"eted 3inised goods-


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etermining Ca"uation and "i%uidity is a !air"y

comp"icated prob"em wen ana"y1inginventories' $e basic approac to teva"uation o! inventory uses cost' $e cost+gure is o!ten di&cu"t to determine, especia""y

wen dea"ing wit manu!acturing inventory'because o! te concept o! conservatism, tecost +gure may not be acceptab"e i! it can notbe recovered' $ere!ore i! te market +gure is

be"ow cost te inventory is reduced to market'Inventory is stated at "ower o! cost or marketon te +nancia" statements

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fra lecture 9

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