2.3.2 - Liquidity

Question 1

What is liquidity

Answer 1

• The ability of a business to turn its assets into cash to pay its current liabilities
• The least liquid assets are listed at the top of the statement of financial position (balance sheet) – premises and specialist machinery for example may take a while to sell, while stock is easy to sell on
• Cash is the most liquid asset of all

Question 2

What is a Statement of financial position (balance sheet)

Answer 2

• A PLC (Public Limited Company) or a LTD (Private Limited Company) business have to publish their accounts by UK law
• One of these accounts is the statement of financial position

Question 3

How do you measure liquidity

Answer 3

• The tools to measure liquidity (ability to pay bills) is the statement of financial position and two key ratios :
• Current ratio
• Acid test ratio

Question 4

What is the current ration formula

Answer 4

• Current assets / Current liabilities

Question 5

What is the acid test ratio formula

Answer 5

Current assets - Inventory / Current liabilities

Question 6

How can liquidity be improved

Answer 6

• A business could reduce the amount of stocks that it holds, so finished goods need to be dispatched faster to customers
• A business could reduce the credit period offered to customers, for example insist that customers pay in 30 days not 90
• A business could also pay suppliers later on agreed credit terms
• Increase borrowing long term and clear the short term debts

Question 7

What is working capital

Answer 7

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

Question 8

What is the working capital cycle

Answer 8

Cask –> Cash paid by debtors for goods or services bought (current assets) –> Sales –> Stock purchased from suppliers on credit (current liability)