Question

Sergey Co. has net cash provided by operating activities of \(1,200,000. Its average current liabilities for the period are \)1,000,000, and its average total liabilities are $1,500,000. Comment on the company’s liquidity and financial flexibility, given this information.

Short answer

The business reflects agood position in terms of financial flexibility and liquidity.

Step-by-step solution

Definition of Financial Flexibility

The ability of the business entity to handle the financial pressure that might arise in different economic conditions is known as financial flexibility.

Liquidity of the Business

$\begin{array}{rcl}\mathbf{Current}\mathbf{}\mathbf{cash}\mathbf{}\mathbf{debt}\mathbf{}\mathbf{coverage}& \mathbf{=}& \frac{\mathbf{Net}\mathbf{}\mathbf{cash}\mathbf{}\mathbf{provided}\mathbf{}\mathbf{by}\mathbf{}\mathbf{operating}\mathbf{}\mathbf{activities}}{\mathbf{Average}\mathbf{}\mathbf{current}\mathbf{}\mathbf{liabilities}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{200}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{000}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{1}\mathbf{.}\mathbf{20}\end{array}$

Conclusion: Current cash debt coverage is 1.20, which means that a business entity can cover all of its current liabilities using the cash generated from operations.

Financial Flexibility of the Business

$\begin{array}{rcl}\mathbf{Cash}\mathbf{}\mathbf{debt}\mathbf{}\mathbf{coverage}& \mathbf{=}& \frac{\mathbf{Net}\mathbf{}\mathbf{cash}\mathbf{}\mathbf{provided}\mathbf{}\mathbf{by}\mathbf{}\mathbf{operating}\mathbf{}\mathbf{activities}}{\mathbf{Average}\mathbf{}\mathbf{total}\mathbf{}\mathbf{liabilities}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{200}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{1}\mathbf{,}\mathbf{500}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{0}\mathbf{.}\mathbf{80}\end{array}$

Conclusion: Cash debt coverage is 0.80, reflecting that the business entity can cover at least 80% of its total liabilities using the cash generated from operations.