FIFO LIFO and Liquidity Ratio

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Reineir

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Guys, can some one please explain to me why it is that the Quick ration will be higher under the LIFO v FIFO, explanation i got is “less taxes” but what are the workings to that conclusion?
Thanks
 
Quick Ratio = (Current Assets - Inv ) / Current Liabilities
So there should be nothing to do with “less taxes” here.
In a period of rising prices –> FIFO Ending Inv > LIFO Ending Inv.
so you are deducting less in the numerator for the Quick ratio calculation.
 
Thanks CP, but does the Quick Ration not subtract Invenotry?
The following was taken from Investopedia:
Quick ration will be higher under the LIFO v FIFO Reasoning “Less Taxes”
I’m confussed??
 
you deduct inventory.
so in FIFO you had 100 Inv.
In Lifo you had 90 Inv.
When you deduct a Lower inventory from the numerator, the numerator is larger – which would be the case in LIFO.
SO you get a higher Quick Ratio, right.
When you are doing liquidity ratios like Quick, Current etc. Net Income, and hence taxes do not have anything to do with the ratio calculations.
 
That Quick Ratio is wrong … its not Current Asset - Inventory. Its Cash +Short term Marketable securities + A/C Rec.
 
That Quick Ratio is wrong … its not Current Asset - Inventory.
Generally its considered (Cash +Short term Marketable securities + A/C Rec.)/CL
Though as with all ratio it depends on the purpose of the analysis and definition which the analyst thinks is most appropriate to the company/sector etc.
 
both are the same…
what else is current assets?
current assets = Cash + marketable Securities + AR + Inv.
So CA - Inv = Cash + marketable Securities + AR
which is what you have, joshua..
 
First of all we should establish whether or not we are in period of rising/stable price or in a period of declining price, because the explantion could reverse depending of the situation.
Now Assuming we are in a period of rising price, we now that:
1.)COGSLIFO>COGSFIFO that mean your taxable income is Lower under LIFO(Lifo reserve) and Higher under FIFO.
2.)Cash flow under LIFO>cash flow under FIFO(Due to the amount of tax paid in each case)
That mean you use less cash to paid tax under LIFO then you do under FIFO: Conlusion you have More cash avalaible under LIFO then under FIFO
conlusion2: Cash is higher under LIFO then under FIFO.
3.) Now since you Current asset include inventory, not matter whether you use LIFO or FIFO, Current asset-Inventory= (cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash) - Inventory
IF you look closely at the above we have only two elements that can change depending on whether you use LIFO or FIFO they are: Cash and Inventory.
Since you are deducting inventory its effects are then neutralized and the only element of potential difference is cash.
Now if you go back to conlusion2 above, we not that cash is higher under LIFO and Lower under FIFO and the reason is because Less tax was paid under LIFO(lifo reserve)
By deduction we can then say quick ration is Higher under LIFO and lower under FIFO because of higher cash which is the result of lower tax.
Hope this helps.
I disagree with cpk123 in the case of the quick ratio, but what he said could be true in the case of the current ratio.
 
Giristide, very well put. That really makes sense. Thank you all
 
Re: FIFO LIFO and Liquidity Ratio new
Posted by: cpk123 (IP Logged) [hide posts from this user]
Date: September 25, 2008 06:23AM
Quick Ratio = (Current Assets - Inv ) / Current Liabilities
So there should be nothing to do with “less taxes” here.
In a period of rising prices –> FIFO Ending Inv > LIFO Ending Inv.
so you are deducting less in the numerator for the Quick ratio calculation.
CP
_ _ _ _ _ _ _
Right - because EI is higher and makes the numerator lower.
Ending Inv = Beg Inv + Purchases - COGS
FIFO method in rising price environment has lower COGS, so higher Ending Inventory
 
Hi projectplatnyc
current Asset include Inventory, quick ratio remove invetory from Current Assets and in the mean time the benefice related to it.
So Quick ration under LIFO being higher ration under FIFO has nothing to do with inventory.
Under LIFO current Assets- Inventory= (cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash) - Inventory (1)
which is equal to current Assets- Inventory= (cash, accounts receivable, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash) (2)
Now under FIFO current assets - Inventory= (cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash) - Inventory (3)
wich is equal to current Assets- Inventory= (cash, accounts receivable, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash) (4)
By looking at closely at (2) and (4) we see this equation have the same elements. But we also now that cash under LIFO is higher than cash under FIFO by deduction quick ration under LIFO is higher than quick ratio under LIFO.
And the reason Why cash is higher under LIFO than under FIFO is because less taxes have been paid.
So the Inventory effect has no impact under the quick Ratio, that is even the essence of the quick ration is to remove the impact of inventory in analysing the company ability to paid is current Liabilities.
 
Please guys,help me to understand the question below. Schweser answer is B.
An analyst gathered the following information about a company:
„X 01/01/06 - 20,000 shares issued and outstanding
„X 04/01/06 - 5.0% stock dividend
„X 07/01/06 - 5,000 shares repurchased
„X 10/01/06 - 2:1 stock split
What is the company¡¦s weighted average number of shares outstanding at the end of 2006?
A) 39,500.
B) 37,000.
C) 45,000.
D) 47,000.
 
1/1 20000
4/1 5% stock dividend
7/1 5000 repurchased
10/1 2:1 stock split
1/1 20000 * 1.05 * 12/12 * 2 = 42000
7/1 -5000 * 6/12 * 2 = -5000
WASO = 37000
Ans B
 
Question about the Stock dividend.
If the question said
X 01/01/06 - 20,000 shares issued and outstanding
„X 04/01/06 - 5.0% stock dividend
NEW - 5/1/06 - 1000 new shares issued
„X 07/01/06 - 5,000 shares repurchased
„X 10/01/06 - 2:1 stock split
Would the 5% stock dividend have to be applied to the new shares issued as well?
Would the answer then have to be:
1/1 - 20000 * 1.05 * 12/12 * 2 = 42000
5/1 - 5000 * 1.05 * 2 * 8/12?
7/1 -5000 * 6/12 * 2 = -5000
 
Nope, you don’t apply the stock dividend to share issues that take place AFTER the stock dividend has been declared.
It would just be 1000*8/12*2
 
thanks but CFA institute’s method is the following:
1/1 Number of shares= 20000 *3/12= 5000
4/1 issuance of 5%stock dividend, Number of shares = 2000*1.05*3/12 = 5250
7/1 Repurchase of 5000, Number of shares= (2000*1.05- 5000)*3/12 = 4000
10/1 split 2:1, Number of shares = (20000*1.05-5000)*2*3/12=8000
total= 22250
Why is Schweser doing it differently?
 
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