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Chapter 8: Problem 26

During 2007, Kinetic Inc. has monthly cash expenses of \(175,000. On December 31, 2007, the cash balance is \)1,575,000. a. Compute the ratio of cash to monthly cash expenses. b. Based upon (a), what are the implications for Kinetic Inc.?

Short Answer

Expert verified
The cash ratio is 9, indicating a strong cash position for Kinetic Inc.

Step by step solution

01

Identify Monthly Cash Expenses

Kinetic Inc. reports monthly cash expenses of \(175,000\). This value represents the operating costs the company incurs every month.
02

Identify the Cash Balance

As of December 31, 2007, Kinetic Inc. has a cash balance of \(1,575,000\). This is the total cash available to the company at that date.
03

Compute the Ratio of Cash to Monthly Cash Expenses

To compute the ratio, divide the cash balance by the monthly cash expenses:\[\text{Ratio} = \frac{1,575,000}{175,000} = 9.\] Therefore, the ratio is 9.
04

Interpret the Ratio for Kinetic Inc.

A ratio of 9 means that Kinetic Inc. has enough cash to cover 9 months of expenses without any additional income. This indicates a good cash position, providing a buffer against unexpected drops in revenue or increases in costs.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

cash flow analysis
Cash flow analysis is a strategy used to track the amount of money moving in and out of a business. It helps identify how a company generates revenue and how it spends money over a certain period.
  • Inflows: This includes all money coming into the business, such as sales revenue, investments, or loans.
  • Outflows: These are expenses like operating costs, material purchases, and salaries.
A cash flow analysis aims to give a clear picture of a company's financial health by ensuring that inflows consistently exceed outflows.
If inflows do not cover outflows, the business might face liquidity issues, potentially affecting its operations. By regularly analyzing cash flow, businesses can identify patterns, forecast future cash positions, and make informed decisions to optimize their financial strategy.
A positive cash flow indicates the company's ability to expand, invest, or pay dividends to shareholders, while a negative one may signal a need for improvement in financial management.
financial ratio analysis
Financial ratio analysis involves using specific formulas to gain insights into a company's performance and financial condition. These ratios help stakeholders evaluate efficiency, profitability, and financial health. One essential ratio is the current ratio, which evaluates liquidity by comparing current assets to current liabilities.
  • The current ratio formula is: \( \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}.\)
  • Different ratios focus on various aspects, like the profitability ratio, which examines a company鈥檚 ability to generate profit relative to sales or assets.
  • Another crucial ratio is the debt-to-equity ratio, assessing financial leverage by relating total liabilities to shareholders' equity.
Through ratio analysis, you gain insights not just into liquidity but also operational efficiency and long-term viability.
These evaluations help management make strategic decisions and allow investors to compare different companies for better investment choices.
business liquidity assessment
Business liquidity assessment measures a company's ability to meet its short-term obligations without raising external capital. Liquidity is crucial for smooth operations and maintaining trust with stakeholders.
  • Key indicators include the quick ratio, which calculates liquidity by excluding inventory from assets,\[\text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}.\]
  • The cash ratio strictly measures cash and cash equivalents against current liabilities for a conservative liquidity view.
Adequate liquidity means a company can settle its immediate debts and handle unexpected expenses without financial distress.
By conducting regular assessments, businesses ensure they have the necessary cash reserves to manage unforeseen challenges, enabling sustained operations.

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Most popular questions from this chapter

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