BUSF_A01.qxd

Chapter 3 • Financial statements and their interpretation

manufacturers have very much higher levels. The difference is almost certainly ex-

plained by the make-up of the current assets. In supermarkets, current assets consist

of cash and fast-moving inventories; supermarkets do not sell on credit (therefore they

have no trade receivables), and, typically, inventories do not stay long on the shelves.

Thus all of their current assets are in a fairly liquid state, being either cash or, in the

normal course of events, items naturally turning into cash within a week or two.

Manufacturers, by contrast, typically sell on credit and, since they need to hold invent-

ories of raw materials, finished goods and some amount of work in progress (WIP),

many of their current assets are, perhaps, several months away from turning into cash.

See Table 13.1 on page 354 for some impression of the relationships between cur-

rent assets and current liabilities (and hence the current ratio) in practice.

Acid test (or quick assets) ratio

The ratio for Jackson plc for 2008 is:

=1.48 : 1

The acid test ratio addresses itself fairly directly to the question: if short-term cred-

itors were to demand payment of their claims more or less immediately, would there

be sufficient liquid assets to meet them? We might ask ourselves whether it is likely

that all the short-term creditors would demand their money at once. The answer is

probably no, provided that they remained confident that payment would be forth-

coming at the normal time. Those advancing credit without cast-iron security, which

would be the position of the typical provider of short-term credit, do so for their own

commercial advantage (for example, in order to sell their products) and they do so

because they have reasonable confidence that they will be paid. Signs, including a

weak acid test ratio, that the business may not be able to pay are likely to erode that

confidence, triggering demands for immediate payment.

What is included in liquid assetsin the calculation of the quick assets ratio is a mat-

ter of judgement. For a supermarket, these would probably include all current assets,

since none of them is likely to be too far away from turning into cash. For a manufac-

turer, they would probably exclude inventories and possibly some receivables.

We can probably say that, in theory, irrespective of the nature of business involved,

this ratio should be about 1 : 1. The difference between the types of business is in

effect adjusted in the definition of liquid assets. See Table 13.1 on page 354 for some

impression of the relationships between liquid assets and current liabilities. This indic-

ates that, in practice, acid test ratios tend not to be as high as 1 : 1 for well-established

businesses.

No credit period ratio

Cash (and near cash)

Average daily cash running costs

133

90

Current assets less inventories

Current liabilities