Evaluating the Liquidity of Retailers Terminating Operations: Lessons to Take to the Classroom

Although firms that go defunct usually have precarious liquidity situations, how often do the financial ratios highlighted in accounting and finance textbooks provide a warning sign? To address this issue, eighteen retailers that issued their last 10-Ks for fiscal years ranging from 2007 through 2018 are matched with similar retailers that continued in business. Little differentiation is seen when current ratios are compared for both sets of firms, as many about-to-be defunct firms continue to report very respectable current-ratio levels. On the other hand, the two sets of firms are clearly distinguished from one another when the focus turns to a cash-oriented liquidity measure, specifically the operating cash flow ratio. In contrast to their surviving peers, the defunct firms reported little if any operating cash in their last 10-K. Cash is what a firm uses to pay its bills, and the current assets of accounts receivable and inventory do not provide a direct substitute for cash when a firm faces a liquidity crises. In a teaching note that follows, students examine whether warning flags were sent up by the two liquidity measures in seven recent retailer bankruptcies and address discussion question that enable them to revisit key points raised in the case.