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Evaluation of Target’s Liquidity Ratios

Paper Type: Free Assignment Study Level: University / Undergraduate
Wordcount: 1501 words Published: 6th Nov 2020

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In this written assignment, a comparison of Target’s 2018 Annual Report versus its 2017 Annual Report. This paper will be focusing on the liquidity ratios of target using their 2018 and 2017 10K reports. The 10K reports were provided or can be accessed by interested users in the Company’s Investor Relations Page. Since the paper is about evaluating the company’s liquidity ratio, the formulas for calculating each ratio will be provided and explained. A company’s liquidity ratio indicates if the company has current assets that can be used to pay off the company’s obligations when they come due. Accounts receivable turnover and inventory turnover both provide insights into a company’s ability to convert its current assets into cash as obligations come due. This essay will be divided into five parts. The introduction, current ratio, accounts receivable turnover, inventory turnover, and conclusion.

The Current Ratio is a method a company uses to measure the proportion of its current assets to its current liabilities.

In Targets 2018 10K Report, it had a total current asset of $12,540,000,000‬ and a current liability of $13,052,000,000. Total current assets consist of cash and cash equivalents, inventory and other assets and their total current liabilities consist of accounts payable, accrued and other current liabilities, and current portion of long-term debt and other borrowings. The total current assets and total current liabilities have changed after adopting Accounting Standards Update (ASU) No. 2014-09— Revenue from Contracts with Customers, ASU No. 2016-02— Leases, and ASU No. 2017-07— Compensation – Retirement Benefits. Using the formula for identifying the current ratio, total current assets must be divided by total current liabilities. $12,540,000 / $13,052,000 = 0.96:1. This means that for every dollar of current liability that Target has, they have $0.96 of current assets. A current ratio of less than 1:1 may indicate insolvency. Prior to adjustment, Target’s total current assets would be $12,564,000 and total current liabilities would amount to $13,201,000. If these amounts were used then the current ratio of Target would have been subtly different (0.95:1). To have a better understanding of the financial life of Target, let us take a look at their current ratio for 2017. Their total current assets from the previous year were $11,990,000 and their total current liabilities were $12,707,000. Its current ratio would then be 0.94:1. Even though they seem to have improved by a tiny fraction, this low amount of assets per liabilities does not look good to internal and external financial users. Having a low current ratio means that the company may not be able to pay its obligations when they come due. This discourages investors from buying stock and especially creditors because they may not get paid back.

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Analysts use the accounts receivable turnover ratio to measure the liquidity of the company’s receivables. This is important because accounts receivables are one of the assets that can be converted to cash easily to pay off the companies liabilities. Receivables are claims that a company owns from customers or other company’s. A simple example of this would be a merchandising company selling inventory to a customer. The customer is expected to pay within the due date before they accrue interest. The formula for calculating a company’s accounts receivable turnover is to divide the net annual credit sales to the average net accounts receivables. 

Accounts Receivable Turnover = Net Annual Credit Sale

Average Net Accounts Receivable

A net annual credit sales is the total amount of sales in a year less returns, allowances, and discounts. An average net accounts receivables is the addition of the company's ending accounts receivable and its beginning accounts receivable, then divided by two. To acquire the net annual credit sale we will need to look at the Consolidated Statement of Operations. In 2018, Target had a net annual credit sale of $2,937,000,000. Their average net accounts receivable for that year was $2,577,500,000 ($2,643,000,000 + $2,512,000,000 / 2). By following the calculation for the accounts receivable turnover, Target’s accounts receivable turnover is 1.14. This low receivables turnover is an indicator that a company has either a poor collection process or weak credit policies. It’s understandable for a company like Target to have low accounts receivables turnover because they don’t rely on customer credit payments, unlike other businesses. In 2017, they had an accounts receivable turnover of 0.89 ($2,914,000,000 / $3,279,000,000). Target’s receivable turnover was really low in 2017 compared to 2018. Again, Target’s low accounts receivable turnover is no surprise. Investors and users know that Target does not depend hugely on their accounts receivables because they are not the type of business to achieve sales through credit.

Another ratio that external users such as investors and creditors look out for is a company’s Inventory Turnover. The inventory turnover ratio helps measure the liquidity of a company’s inventory. How many times a company has sold its inventory in a period of time. As a retailer, Target has to have good management of their inventory. A low inventory may make them lose sales and high inventory may cost them more expenses. Therefore, a company should carefully monitor their inventory. The formula for inventory turnover is to divide the cost of goods sold to average inventory.

Inventory Turnover =  Cost of Goods Sold

Average Inventory

The inventory of a company is in the Consolidated Statement of Financial Position or the company’s Balance Sheet. The cost of goods sold is the cost of the products that the retailer or distributor sold. This is found in the company’s income statement because this is considered as an expense. In 2018, Target had an inventory amount of $8,597,000,000 (As adjusted) and an inventory amount of $8,309,000,000 in the previous year. Target’s 2018 average inventory for 2018 is $8,453,000,000 ($8,597,000,000 + $8,309,000,000 / 2). Their 2018 amount of cost of goods sold is $53,299,000,000. By following the inventory turnover ratio formula, Target’s inventory turnover is 6.3 times.If we convert it to days in inventory (365 / inventory turnover) it shows that target holds inventory for about 58 days. In 2017, Target’s inventory turnover is 6.0 times. In days in inventory, they held their inventory for 61 days. They made a small improvement with their inventory turnover from 2017 to 2018. External users of 10K reports look at a company’s inventory turnover because this will help them know if they’re monitoring their inventory properly. Inventory is one of the assets that are easily converted to cash so that a company can pay off its obligations when it comes due.

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Target’s liquidity ratios (current ratio, accounts receivable turnover, and inventory turnover) is a good indicator if they will be able to pay their obligations when it comes due. Accounts receivable and inventory are current assets that can be easily converted to cash that’s why they are also a measurement of a company's liquidity. These are the ratios that external users watch out for because they want to be confident that to whoever they will lend money to, they will surely be paid back.

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