Liquidity of Dollar Tree Store
The current ratio of Dollar Tree Store Limited minimally deteriorated during the years examined. This shows particular concern on working capital management of the firm, because such ratio reveals the ability of the organization to pay its current liabilities out of the current assets. However the acid test ratio, which represents the capability of the firm to cover the current liabilities out of the most liquid assets improved during the years. Therefore we can contend that the decrease in working capital probably arose primarily from a decrease in inventory.
Thus the corporation’s ability to meet current liabilities improved from 2005 to 2006. Even though the inventory level decreased by the organization, the stock turn ratio indicates that management was more effective in the management of stock. Indeed the stock turn ratio increased from 3. 53 times to 3. 7 times. This portrays that managers were more able to dispose of the stock held faster. This is very positive for the liquidity of Dollar Tree Store because the higher the ratio, the less the money tied up in stock.
Several organizations encounter cash flow problems due to the high amount of stock they hold which diminishes the availability of money and increases the holding costs of stock. This does not apply to the company examined. The organization selected operates as a discount variety store offering merchandise at fixed prices. The majority of the sales are made by cash, cheque or MasterCard/Visa credit cards. The materiality of trade receivables from debtors is thus low as indicated in the Balance Sheet itself.
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Therefore we did not determine the ratios on debtors collection period due to its insignificance. As we can see the decrease in the current ratio of Dollar Tree Store is mainly due to a decrease in cash and cash equivalents and inventories. However, in the opening paragraph of this section we stated that the acid test ratio increasing indicating a better ability to cover the current liabilities. First we need to investigate the reasons behind the decrease in cash and cash equivalents, which are performed by analyzing the cash flow statement of the firm.
The net cash flow generated from operating activities increased by 32. 07%, indicating positive managerial ability to create cash from the corporation’s operations. The drastic decrease in cash and cash equivalents was mainly due to the redemption of stock, which amounted to $169,731,000. Dollar Tree Store cash and cash equivalents is still positive at the financial year end 2006 by $65,834,000. Therefore there is nothing to be alarmed about with respect to cash flow. If management continues to adopt good cash management practice as they are doing, the cash flow position will soon improve.
As we have seen the decrease was mainly due to a change in the firm’s capital structure. With respect to the acid test ratio increase, which were mainly due to a decrease in short term debt and other current liabilities, which compensated the decrease in cash and cash equivalents. The other current liabilities comprise compensation benefits due, taxes other than corporation tax, insurance and other expenditure due. We can thus contend that the working capital position of Dollar Tree Store is still good with a net current assets of $648,220,000.