2.3.2 Liquidity

Question 1

statement of financial position

balance sheet

Answer 1

• 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

Question 2

two sides of a balance sheet

Answer 2

(Non current assets + Current assets + Current liabilities- Non current liabilities = net assets

Share capital + Reserves (retained profit over years) = capital and reserves (total equity)

Question 3

net assets

Answer 3

must equal total equity (both figures must be balanced)

Question 4

non-current and current assets

Answer 4

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

Question 5

current and non-current liabilities

Answer 5

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)

Question 6

creditor and debtors

Answer 6

creditor = payables

debtor = receivables

Question 7

3 accounts

Answer 7

statement of comprehensive income (PAST)
statement of financial position (PRESENT)
cash flow forecast (FUTURE)

Question 8

net assets equation (also working capital)

Answer 8

non current assets + (current assets - current liabilities) - non current liabilities

Question 9

working capital (net current assets)

Answer 9

-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

Question 10

total equity

Answer 10

total amount of money invested in business from share capital and retained profit

share capital + retained profit

Question 11

least liquid current asset

Answer 11

in statement of financial position = inventories

liquid = turn to cash

-commenting on business liquidity position = look at net current assets

Question 12

goodwill

Answer 12

reputation for good quality included as good will in intangible assets

Question 13

equity capital

Answer 13

share capital and retained earnings

Question 14

interpreting statement of financial position

Answer 14

• look at short term net current assets
• look at each section
• compare borrowed money with equity

Question 15

liquidity ratios

Answer 15

able to meet its short term liabilities & debts

• business’ cash position (pay bills?)
• making profit but unable to pay bills

1. current ratio
2. acid test

Question 16

current ratio

Answer 16

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)

Question 17

acid test

Answer 17

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.

Question 18

what measures can a business take to improve liquidity ?

Answer 18

-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

Question 19

if liquidity ratio is low?

Answer 19

• 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

Question 20

measure of liquidity

Answer 20

ability to convert an asset into any form usually cash without any delay

Question 21

5 stages of liquidity cycle

Answer 21

1. capital injection
2. produce goods
3. sell to customers (credit or cash) (if credit = delay)
4. customers pay (receivables) (delay if dont pay on time)
5. buy materials (delayed if given trade credit)

Question 22

why is working capital important to a business?

Answer 22

-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)

Question 23

causes of working capital problems

Answer 23

• 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

Question 24

ways to improve working capital

Answer 24

• 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)