2.3 : Liquididity

Question 1

What is an income statement ?

Answer 1

Measures the businesses’ performance over a given period of time, it compares the income of the business to the costs of goods or services incurred in making that revenue.

Question 2

What is a statement of financial position ?

Answer 2

Is a snapshot of the business’s assets + its liabilities on a particular day - usually the last day of the financial year.

Question 3

What is a cash flow statement ?

Answer 3

Shows how the business has generated and disposed of cash and liquid funds during the period under review.

Question 4

What does liquidity assess in a business ?

Answer 4

Assesses whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due.

Question 5

What is the equation for current ration ?

Answer 5

Current assets / current liabilities

Question 6

What will the results of a current ratio suggests ?

Answer 6

Ratio of 1.5-2.0 would suggest sufficient management of working capital. Low ratio indicates cash problems and high ratio would mean they have too much working capital.

Question 7

What to look out for with current ratio ?

Answer 7

Industry norms since they have low ratios since they low debtors. Trend (change in ratio) is perhaps most important.

Question 8

What is the equation for the acid test ratio ?

Answer 8

Current assets less stock / current liabilities

Question 9

What do the results of the acid test ratio tell a business ?

Answer 9

A good warning sign of liquidity problems for businesses hat usually hold stocks Significantly less than 1 is often and news.

Question 10

What is there to look out for with the acid test ratio ?

Answer 10

Less relevant for businesses with high stock turnover. Trend : significant deterioration in the ratio and indicate liquidity problems

Question 11

What are the causes of cash flow problems ?

Answer 11

Low profits or losses, too much production capacity, excess inventories held, allowing customers too much credit + too long to pay, overtrading - growing the business too fast, seasonal demand

Question 12

What are the keys to managing cash flow problems ?

Answer 12

Reliable and regular cash flow forecasting, managing working capital, having sufficient and suitable sources of finance

Question 13

How do you manage working capital effectively ?

Answer 13

Debtors, creditors, inventories

Question 14

What is debtors ?

Answer 14

Amounts owed by customers

Question 15

What is creditors ?

Answer 15

Amounts owed by suppliers

Question 16

What are inventories ?

Answer 16

Cash tied up in raw materials , work n progress and finished goods

Question 17

How to improve cash flow from debtors ?

Answer 17

Effective credit control, offer cash discounts for prompt payments, improve record keeping, potentially use debt factoring

Question 18

What is debt factoring ?

Answer 18

The selling of debtors to a third party, this generates cash, it guarantees the firm a percentage of money owed to it but will reduce income and profit margin made on sales. Cost involved in factoring can be high

Question 19

How to improve cash flow from creditors ?

Answer 19

Trade credit, Delayed payments means that a business retains cash longer, Trade creditors are seen as a free source of capital

Question 20

How to improve cash flow from inventory ?

Answer 20

Keep smaller balances (just in time stocks), computerise ordering to improve efficiency, improve stock control. This will cut down the spending on stock but may leave the business vulnerable to stock outs.