2.3.2 Liquidity

Question 1

What are long term assets (Non-current assets)?

Answer 1

Long-term resources that will be used by the business repeatedly over a period of time.

Question 2

What are some examples of long-term assets?

Answer 2

• Machinery
• Technology
• Property
• Vechiles

Question 3

What are some examples of current assets?

Answer 3

• Stock
• Debtors
• Cash

Question 4

Define liquidity

Answer 4

The ability of a business to turn its assets into cash to pay its current liabilities.

Question 5

What are the 3 ways we can measure liquidity?

Answer 5

1. ) Statement of financial position
2. ) Current ratio
3. ) Acid test ratio

Question 6

What is the current ratio formula?

Answer 6

Current assets / Current liabilities

Question 7

What is the Acid test ratio formula?

Answer 7

Current assets - Inventory / Current liabilities

Question 8

What are the 4 ways liquidity can be improved?

Answer 8

• Reducing the amount of stocks they hold
• Reduce the credit period offered to customers
• Pay suppliers later on agreed terms
• Increase borrowing long term and clear short term debts

Question 9

What is working capital?

Answer 9

Working capital means the day-to-day finance needed in a business and can be calculated by CA - CL

Question 10

Example of a current ration analysis (Burberry).

Answer 10

-Burberry has a CR of 2.9:1
-This means that for every 1£ of debts they have £2.90 of assets they can quickly turn into cash.
-The ideal ratio is 1.5:1, lower than this + there is not enough money to pay bills.
-Higher than this + there is too much money tied up in stock (but with Burberry being a high end retailer the current ratio looks about right for holding high value of stock.)

Question 11

Acid test conclusions

Answer 11

-Harsher test of liquidity because you cannot guarantee to sell all of the stock. Stock can also spoil, become obsolete or just go out of fashion.
-If a business has an acid test ratio of less than 1:1 then it’s current assets (minus stocks) do not cover it’s current liabilities.
-This could mean a problem for the business.
-Again some retailers with strong cash flow + fast moving stocks may have an acid test of 0.4:1 and be fine, it depends on the industry.

Question 12

What is the order of the working capital cycle?

Answer 12

1.) Cash —> 2.) Cash paid by debtors for goods/services bought (current assets) —> 3.) Sales —> 4.) Stock purchased from suppliers on credit (current liabilities) —> 1.) Cash