How has JCF managed its working capital accounts over the past eight
quarters? Is there an opportunity to squeeze more cash from any of
these accounts?
Working capital refers to the excess of current liabilities over the current liabilities.
In that sense JC Penny keeps in all the quarter of 2012 and 2011 positive working
capital.
Now let us examine whether the JC Penny keeps the desirable Current Ratio or not?
Current ratio refers to the current asset/current liabilities. The desirable current
Ration is 2:1. In that sense in 2012 all quarters are not meeting the exact ratio, but
they are near to 2:1 except in Quarter 4. But in that quarter also JC Penny keeps the
ratio more than one. In 2011 all quarters are also almost meeting the desirable ratio.
Generally, a firm’s current ratio should be proportional to its operating cycle. The
shorter the operating cycle is, the lower the current ratio can be because the operating
cycle will generate cash more quickly for a firm with a shorter operating cycle than
it will for a firm with a longer operating cycle. The cash generated can be used to
settle the liabilities.
The effective management of working capital requires that working capital be kept
as low as possible while at the same time being balanced against the risk of illiquidity
(the inability to satisfy current liabilities with current assets). Companies with an
aggressive financing policy that are willing to assume more risk of illiquidity will
have lower current ratios, while companies with conservative financing policies will
have higher current ratios. The less risk the company’s management wants to
assume, the higher its level of working capital must be.
The standard for the current ratio is 2:1. A lower ratio indicates a possible liquidity
problem.
The quality of the accounts receivable and merchandise inventory should be
considered when assessing a company’s current ratio. If the inventory and
receivables can be quickly converted to cash, then a lower level of working capital
and thus a lower current ratio can be maintained. However, if the receivables and
inventory cannot be easily converted to cash, higher levels of working capital are
necessary . page 15
The length of time required for accounts receivable and inventory to be converted to
cash is measured by the receivables turnover and inventory turnover ratios. A low
receivables turnover and a low inventory turnover indicate the need for a higher level
of cash and cash equivalents. page 15
In interpreting a company’s current ratio, it is important to be aware of its
limitations. The current ratio is actually only an indication of what would
happen if cash flows were to stop completely and today’s current assets
had to be liquidated to pay off today’s current liabilities. This is seldom
the question an analyst wants answered. To answer the questions that an
analyst needs answers to, cash flow projections are required. However, the
current ratio continues to be used because it is simple and understandable
and the information needed to calculate it is readily available.
The cash ratio is a liquidity ratio that measures a company's ability to pay
off short-term liabilities with highly liquid assets. ... There is no ideal
figure, but a ratio of at least 0.5 to 1 is usually preferred. But in that sense
the company is not keeping the desirable ratio is 2012. Aggregate ratio is
0.312 for entire 2012. But for 2011 it is 0.52. so company could keep the
desirable ratio in 2011.
Ways to squeeze more cash from available source of accounts:
1- Improve inventory turnover ratio (Avoid stockpiling)
Inventory turnover ratio or days sales inventory is a method of effective
inventory management. The higher the inventory ratio, the higher the
efficiency. It indicates how fastly the company could generate sales out of
its average inventory. This will lead to unwanted stuck of cash in
inventories. If the company can keep a lower inventory without affecting
the sales of the company they can squeeze more cash from inventories and
improve their cash ratio.
2- Lower the Days Sales Outstanding (DSO).
By doing so they can quickly collect the money from the debtors and avoid
the liquidity problem. Lower the DSO , higher the efficiency. So company
can maximum try to lower the collection period with a standard credit
policy and strictly follow it. DSO is also called Debtors Turnover Ratio.
3- Higher the creditors Turnover ratio (Leverage Your Accounts Payable)
Negotiate with suppliers to extend the credit facility. By doing so the
company can keep more liquidity, means more cash balance int their hand
and improve the cash ratio.
Page 16
some other ways to improve the cash positions:
1- Lease the equipments.
2- Improve the sales revenue.
3- Avoid unnecessary expenses.
4- try to implement Just In Time system.