2.3.2 Liquidity Flashcards
Liquidity
Means the ease and cost with which assets can be turned into cash and used immediately as a means of exchange
Statement of financial position
A formal financial document that summarises the net worth of a business at a given point in time.
Assets
Include all things that could benefit the organisation. Those that appear of the statement of financial comprehension are the ones that can be given monetary value
Liabilities
Includes all debts that must be repaid at some point in the future
Non current assets
Likely to be kept by the business for more than one year eg vehicles, premesis and machinery
Current assets
Likely to be turned into cash within a year eg inventories, debtors, cash
Non current liabilities
Debts that the business has more than one year to replay eg bank loans
Current liabilities
Debts that the business may have to repay within one year eg overdrafts and creditors
Why are liquidity ratios important
Suppliers want to see health of business, investors want to see how healthy business before buying shares.
Current ratio
Indicates if the business can pay debts due within one year out of current assets. Answer is always expressed as a ratio
Ideal current ratio
1.7-2.0 because suggests that the business has enough cash to be able to pay its debts but not too much tied up in assets
What is a low current ratio
1-1.5 might suggest that the business is not well placed to pay its debts
What is the acid test ratio
Makes current ratio more accurate by taking away stocks from the current assets total.
What is an ideal acid test ratio
Ideally 1.0 is good
How can a business improve liquidity
Increase current assets or reduce current liabilities. Sell assets no longer being used, use debt factoring service, implement JIT
