Can it pay, and is “too liquid” a thing

Two balance-sheet measures

Liquidity is the ability to pay the bills falling due in the next year. The current ratio compares everything expected to turn into cash within the year against everything due within it:

$$\text{Current ratio}=\frac{\text{Current assets}}{\text{Current liabilities}}=\frac{1,600}{700}=2.29$$

Tamarack has $2.29 of current assets for every dollar of current liabilities. But 720 of those current assets are inventory — tents that must be sold before they are cash, in a season that may not co-operate — and 60 are prepaids, which will never be cash at all (they are next year’s rent and insurance, already paid). The quick ratio (acid test) keeps only the assets that are cash or one step from it:

$$\text{Quick ratio}=\frac{\text{Cash}+\text{Short-term investments}+\text{Receivables}}{\text{Current liabilities}}=\frac{220+0+600}{700}=1.17$$

In this course the quick ratio excludes both inventory and prepaids. A definition that takes current assets minus inventory would leave the prepaids in; when a source quotes a quick ratio, check which it used.

Three cash-flow measures

Balance-sheet liquidity is a snapshot. The cash-flow statement adds the flow that services the liabilities:

$$\text{Operating cash flow ratio}=\frac{\text{CFO}}{\text{Current liabilities}}=\frac{460}{700}=0.66$$

$$\text{Current cash debt coverage}=\frac{\text{CFO}}{\text{Average current liabilities}}=\frac{460}{650}=0.71$$

A year’s operating cash covers about two-thirds of the current liabilities outstanding — normal for a retailer whose payables turn over several times a year, and read against the trend rather than a fixed benchmark. The two ratios differ only in the denominator (closing versus average); state which one you used.

$$\text{Free cash flow}=\text{CFO}-\text{Capital spending}=460-440=20$$

Free cash flow is what is left after the business has paid for its own growth — the cash available for debt repayment, dividends and buy-backs without borrowing. Tamarack’s 20 says the 2025 expansion consumed almost everything operations produced; the 80 of dividends was, in effect, funded by the 100 of new borrowing. Definitions of free cash flow vary between analysts (some deduct only replacement capex, some deduct dividends too); this course’s is CFO less total capital spending, and it is subtraction — CFO plus capex is a common slip.

After the write-down

Lesson 9.4’s 300 inventory write-down reduces current assets to 1,300: the current ratio falls to 1,300 ÷ 700 = 1.86. The quick ratio is unchanged at 1.17 — inventory was never in it. That is the acid test doing its job: it was already refusing to count the tents.

Why a current ratio of 4 might be bad

A current ratio of 4.0 sounds safer than 2.29. It might be. It might also mean 1,500 of cash idling at a chequing-account rate, receivables from customers who are not paying, and inventory nobody wants. Every dollar sitting in current assets is a dollar not earning a return in the business — lesson 9.6’s liquidity-versus-profitability tension — and it drags asset turnover and ROA down. The right current ratio is enough to pay the bills with a margin for a bad season, and no more. A ratio that is rising because inventory is piling up is a warning, not a comfort; read it with days inventory (lesson 9.5) before deciding which.