2.3.2 Liquidity Flashcards
What is liquidity?
amount of cash a business has and it shows if they have enough cash to pay debts over the coming months
What will happen if a business has liquidity problems?
It won’t be able to pay short-term debts and if continues it will be insolvent
What does insolvent mean
Unable to pay their bills
What is working capital?
The capital of a business which is used in its day-to-day trading operations
What must a business have to run efficiently?
working capital to pay wages, bills etc
What does a statement of financial position show? (balance sheet)
shows the financial structure of a business at a specific point in time
It identifies a business’s assets and liabilities to see if they’re able to pay their bills over the next 12 months
What are assets?
What the business owns
What are fixed assets?
(non-current)
Assets that the business has kept for more than 1 year
(creates revenue for business eg machinery)
What are current assets?
Assets that the business expects to keep for less than 1 year
(raw materials)
(converted to cash fast)
What are liabilities?
What the business owes
What are long-term liabilities?
(non-current)
Debts that will be paid back over 1 year
(eg, mortgage, property loan)
What are current liabilities?
Debts that will be paid back within 1 year
(eg, overdraft, trade credit)
What does the total equity section on a balance sheet show?
The value of a company’s assets after deducting liabilities
Shows the business’s net worth
What is the formula for net assets (equity)?
Total assets - total liabilities
What does the current ratio show?
How many times short-term debts can be paid out of current assets
The result indicates how many £s of current assets it has available to cover each £1 of short-term debt
What is the current ratio formula?
Current assets / current liabilities
If the current ratio is under one what does this mean?
The business is in trouble
What is an acid ratio test?
How many times short-term debts can be paid out of current assets But MINUS stock
Why does an acid ratio test take off the stocks?
because they’re not easy to sell at full value and they’re hard to turn into cash so its a more realistic measure
What is the formula for the acid ratio test?
current assets - stock / current liabilities
How can a business improve liquidity?
3x examples
By bringing more working capital into the business
By..
Using short and long term loans
Cutting unnecessary expenses
Increasing sales
What is working capital?
The amount of money needed to pay for day to day trading
(What’s left after current debts have been paid)
Why does a business need working capital?
To pay for expenses like wages and electricity and components to produce products
What is the formula for working capital?
Current assets- - current liabilities
What will happen to working capital if the business is struggling?
It will have low working capital
What 3 things influence a businesses working capital needs?
Size
Stock levels
Debtors and Credtors
What difference in working capital will there be in a small size business in comparison to a large size business?
small- will need less WC as the business will have less employees therefore less wages and smaller premises therefore smaller bills
Big- require more so they need to pay for more eg machinery and staff
What difference in working capital will there be in a low and high stock level business’ ?
high stock-eg retailers, need large amounts of WC to pay for stock and warehouses
Low stock-eg hairdressers, dont need as much as no need to purchase stock
What is slow and quick cash conversion cycle?
slow- eg Chanel invest a lot in stock but items not sold as fast
High- eg retailers stock arrives fast and they sell it fast so cash for stock not an issue as earns back straight away
What difference in working capital will there be in a debtor in comparison to a credtor?
debtor- owes money (needs more WC)
Credtor- owed money (needs less WC)
Why does a business need to maintain adequate levels of working capital?
Because it needs enough to run the business day to day
What may happen if a business has too much stock?
May be kept for a long time and go out of date or obselete
What may happen if a business has too much cash?
The business may fall into sloppy habits including inadequate control of spending
What is cash?
The coins and notes a business keeps on the premises and the money the business has in the bank
What does it mean that cash is the most liquid of all business assets?
Its the most readily available and accessible
Is cash the same as working capital?
It is not the same but cash is a part of Woking capital
