2.3.2 Liquidity

Question 1

What is liquidity?

Answer 1

the ease and cost with which assets can be turned into cash and used immediately as a means of exchange.

Question 2

What is a asset?

Answer 2

resources owned by a business such as building, vehicles, machinery and equipment

Question 3

What is a liability?

Answer 3

These are the debts of a business such as a bank loan, money owed to suppliers or tax due to paid

Question 4

What is Capital?

Answer 4

This is the money invested into the business by the owners

Question 5

What are non-Current assets?

Answer 5

These are long term assets such as buildings and machinery that are held for 1 year plus and cannot quickly be converted into cash

Question 6

What are current assets?

Answer 6

these are assets that can be changed into cash within 12 months. They usually include stock, trade receivables and even cash itself is included under this category

Question 7

What are current liabilities?

Answer 7

these are debts due to be paid within 12 months. It could include amounts due to suppliers (trade payables), tax due, overdrafts, short term bank loans

Question 8

What are non-current liabilities?

Answer 8

these are long term debts that will take more than one year to repay. They may include mortgages, long term loans and pension funds.

Question 9

What is the current ratio?

Answer 9

this ratio measures how easily a business can pay their current liabilities

Current ratio = Current assets / Current liabilities

Question 10

How is the current ratio shown?

Answer 10

In a ratio

EG: £1.80 : £1.00

Question 11

What is a good current ratio?

Answer 11

At least 1.5:1

However if the ratio is above 2:1 then it may show that too much money is tied up in current assets

Question 12

What is the Acid Test Ratio?

Answer 12

Current assets - Inventories / Current liabilities

Very similar to the current ratio BUT it deducts stock (inventories) from the current assets.

Question 13

What should a acid test ratio be?

Answer 13

Ideally, an Acid test ratio should be higher than 1 : 1

This tells us that even without stock, there is enough cash and trade receivables to pay any current liabilities (short term debts).

Question 14

What is working capital?

Answer 14

This is the amount of money a business has available to for their day to day running costs.

Question 15

How to improve liquidity?

Answer 15

1. Use your overdraft facilities
2. Short and long term loans
3. Sell stock