2.3.2 Liquidity

Question 1

What is liquidity?

Answer 1

amount of cash a business has and it shows if they have enough cash to pay debts over the coming months

Question 2

What will happen if a business has liquidity problems?

Answer 2

It won’t be able to pay short-term debts and if continues it will be insolvent

Question 3

What does insolvent mean

Answer 3

Unable to pay their bills

Question 4

What is working capital?

Answer 4

The capital of a business which is used in its day-to-day trading operations

Question 5

What must a business have to run efficiently?

Answer 5

working capital to pay wages, bills etc

Question 6

What does a statement of financial position show? (balance sheet)

Answer 6

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

Question 7

What are assets?

Answer 7

What the business owns

Question 8

What are fixed assets?
(non-current)

Answer 8

Assets that the business has kept for more than 1 year
(creates revenue for business eg machinery)

Question 9

What are current assets?

Answer 9

Assets that the business expects to keep for less than 1 year
(raw materials)
(converted to cash fast)

Question 10

What are liabilities?

Answer 10

What the business owes

Question 11

What are long-term liabilities?
(non-current)

Answer 11

Debts that will be paid back over 1 year
(eg, mortgage, property loan)

Question 12

What are current liabilities?

Answer 12

Debts that will be paid back within 1 year
(eg, overdraft, trade credit)

Question 13

What does the total equity section on a balance sheet show?

Answer 13

The value of a company’s assets after deducting liabilities
Shows the business’s net worth

Question 14

What is the formula for net assets (equity)?

Answer 14

Total assets - total liabilities

Question 15

What does the current ratio show?

Answer 15

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

Question 16

What is the current ratio formula?

Answer 16

Current assets / current liabilities

Question 17

If the current ratio is under one what does this mean?

Answer 17

The business is in trouble

Question 18

What is an acid ratio test?

Answer 18

How many times short-term debts can be paid out of current assets But MINUS stock

Question 19

Why does an acid ratio test take off the stocks?

Answer 19

because they’re not easy to sell at full value and they’re hard to turn into cash so its a more realistic measure

Question 20

What is the formula for the acid ratio test?

Answer 20

current assets - stock / current liabilities

Question 21

How can a business improve liquidity?
3x examples

Answer 21

By bringing more working capital into the business
By..
Using short and long term loans
Cutting unnecessary expenses
Increasing sales

Question 22

What is working capital?

Answer 22

The amount of money needed to pay for day to day trading

(What’s left after current debts have been paid)

Question 23

Why does a business need working capital?

Answer 23

To pay for expenses like wages and electricity and components to produce products

Question 24

What is the formula for working capital?

Answer 24

Current assets- - current liabilities

Question 25

What will happen to working capital if the business is struggling?

Answer 25

It will have low working capital

Question 26

What 3 things influence a businesses working capital needs?

Answer 26

Size
Stock levels
Debtors and Credtors

Question 27

What difference in working capital will there be in a small size business in comparison to a large size business?

Answer 27

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

Question 28

What difference in working capital will there be in a low and high stock level business’ ?

Answer 28

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

Question 29

What is slow and quick cash conversion cycle?

Answer 29

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

Question 30

What difference in working capital will there be in a debtor in comparison to a credtor?

Answer 30

debtor- owes money (needs more WC)

Credtor- owed money (needs less WC)

Question 31

Why does a business need to maintain adequate levels of working capital?

Answer 31

Because it needs enough to run the business day to day

Question 32

What may happen if a business has too much stock?

Answer 32

May be kept for a long time and go out of date or obselete

Question 33

What may happen if a business has too much cash?

Answer 33

The business may fall into sloppy habits including inadequate control of spending

Question 34

What is cash?

Answer 34

The coins and notes a business keeps on the premises and the money the business has in the bank

Question 35

What does it mean that cash is the most liquid of all business assets?

Answer 35

Its the most readily available and accessible

Question 36

Is cash the same as working capital?

Answer 36

It is not the same but cash is a part of Woking capital