2.3.2 Liquidity Flashcards
statement of financial position
balance sheet
- financial document
- summarises net worth of a business (records assets/liabilities)
- tells you way business has raised its capital and uses to which capital has been put
two sides of a balance sheet
(Non current assets + Current assets + Current liabilities- Non current liabilities = net assets
Share capital + Reserves (retained profit over years) = capital and reserves (total equity)
net assets
must equal total equity (both figures must be balanced)
non-current and current assets
NON-CURRENRT: own for long period of time
e.g land, building, plant, property, equipment, machinery, goodwill/other tangibles (customer base) and brand name
CURRENT:
e.g. cash balances/cash equivalent, trade debtors (receivables), inventories (stock), short term investment
current and non-current liabilities
CURRENT:
e.g. trade creditors (payables), short term borrowing= overdraft (business can spend more than their account), tax, short term loan
NON-CURRENT:
e.g long term borrowings (loan) and long term liabilities (mortgage)
creditor and debtors
creditor = payables
debtor = receivables
3 accounts
statement of comprehensive income (PAST)
statement of financial position (PRESENT)
cash flow forecast (FUTURE)
net assets equation (also working capital)
non current assets + (current assets - current liabilities) - non current liabilities
working capital (net current assets)
-net current assets
-day to day finance used in business (sufficient funds to meet business needs)
-keeps cash moving through cycle = enough for future orders
-measure of liquidity
current assets - current liabilities
total equity
total amount of money invested in business from share capital and retained profit
share capital + retained profit
least liquid current asset
in statement of financial position = inventories
liquid = turn to cash
-commenting on business liquidity position = look at net current assets
goodwill
reputation for good quality included as good will in intangible assets
equity capital
share capital and retained earnings
interpreting statement of financial position
- look at short term net current assets
- look at each section
- compare borrowed money with equity
liquidity ratios
able to meet its short term liabilities & debts
- business’ cash position (pay bills?)
- making profit but unable to pay bills
- current ratio
- acid test
current ratio
ability to meet debts over next year
current assets divided by current liabilities
ideal value between 1.5 and 2
-varies on types of business
(fast food/banks = lower as they deal in cash) (manufacturing higher ratios = lots of stock)
acid test
measures very short term liquidity
-more accurate indicator as it takes out inventories (stock) which is considered to be less liquid than cash
current assets - stock divided by current liabilities
ideal values 0.75 -1 larger than 1 as trade mainly in cash.
what measures can a business take to improve liquidity ?
-reduce stock, payables and loans/overdraft
- too low = business at risk from insolvency
- too high = business not taking adv of possible investment opportunities
-improve by raising more cash, selling non-current assets (sell and lease back) or agreeing long-term borrowing and reducing short term borrowing
if liquidity ratio is low?
- becomes hard to pay bills
- company will have to try to bring more cash into balance sheet by:
- selling underused fixed assets
- raising more share capital
- increasing long term borrowings
- postponing planned investments
measure of liquidity
ability to convert an asset into any form usually cash without any delay
5 stages of liquidity cycle
- capital injection
- produce goods
- sell to customers (credit or cash) (if credit = delay)
- customers pay (receivables) (delay if dont pay on time)
- buy materials (delayed if given trade credit)
why is working capital important to a business?
-survive day to day, (machines/stock/wages/bills)
- small bus delay pay = limited access to funds
- expanding bus increase expenditure impact working capital
- bus = long working capital cycle= incur costs (unpredictable)
causes of working capital problems
- external changes and Internal problems
- high start up costs, expansion or taking extra orders (too quickly)
- give customers credit but supplier not giving credit
- too much stock/failing to control levels
- poor control of creditors and debtors
ways to improve working capital
- allowance for uncertainty
- minimising spending on fixed assets
- minimising stock levels (effective stock management)
- keeping customer credit as low as possible trying to get as much credit from suppliers (getting them goods quicker = quicker payments)
- reduce trade credit and negotiate extra credit
- cut production costs,sale and leaseback/redundant asset
- negotiate additional short term loans (financial planning)
