WORKING CAPITAL ANALYSIS - LIMITATIONS OF A VALUABLE TOOL

A COMPANY'S ABILITY TO REMAIN SOLVENT AND SERVICE ITS SHORT-TERM OBLIGATIONS IN A TIMELY MANNER IS EXTREMELY IMPORTANT AND SHOULD RECEIVE CLOSE SCRUTINY. PERHAPS THE MOST COMMONLY EMPLOYED TOOL USED TO MEASURE A COMPANY'S LIQUIDITY IS THE ANALYSIS OF WORKING-CAPITAL. HOWEVER, SUCH ANALYSIS DOES HAVE SOME IMPLICATIONS AND PITFALLS. COMPANY MANAGEMENTS ARE IN A POSITION TO 'ALTER AND IMPROVE' BOTH CURRENT AND ACID-TEST RATIOS - ENHANCING THE FIRM'S COSMETIC APPEARANCE - BY EXTINGUISHING CURRENT NOTES PAYABLE WITH CURRENTLY AVAILABLE CASH. ANOTHER TECHNIQUE, POTENTIALLY CAPABLE OF EVEN MORE DRAMATIC EFFECT UPON BOTH THE FINANCIAL RATIOS AND WORKING CAPITAL AS WELL, INVOLVES REFINANCING SHORT-TERM DEBT WITH LONG-TERM DEBT. THE WAY A COMPANY FIGURES ITS INVENTORY - WHETHER IT USES THE LIFO OR THE FIFO METHOD - ALSO HAS A SIGNIFICANT EFFECT ON FINANCIAL AND REPORTING STATEMENTS. ANALYSTS SHOULD UNDERSTAND THE CONSTRUCTION OF WORKING CAPITAL ACCOUNTS. TABLES.