2.3.2 Liquidity Flashcards

1
Q

liquidity

A

the ability of a business to meet its short term commitments with its available assets

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2
Q

why is managing liquidity important?

A

a business that cannot pay its bills will usually fail very quickly, even if they are profitable
-managing liquidity is a key way to manage risk in a business- helps a business prepare for the unexpected

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3
Q

what does the Statement of Financial Position contain?

A

the financial information required to draw conclusions about the liquidity of the business
-it shows it at a specific point in time
-identifies its assets and liabilities, specifying the capital used to fund the business

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4
Q

whats another name for the Statement of Financial Position?

A

the Balance Sheet

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5
Q

non-current assets and examples

A

items that are owned by a business for the long-term
e.g. machinery and buildings

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6
Q

current assets and examples

A

items that are converted to cash quickly, usually within 12 months
e.g. cash, trade receivables and inventory

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7
Q

current liabilities and examples

A

money a business owes and is due to be settled soon- within 12 months
e.g. trade payables, short term borrowing like a bank overdraft.

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8
Q

non-current liabilities and examples

A

money a business owes and that does not need to be paid back for at least 12 months
e.g. bank loans and mortgages

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9
Q

net assets equation

A

assets - liabilities

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10
Q

another word for net assets

A

capital employed

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11
Q

cash flow statement

A

this shows how the business has generated and disposed of cash and liquid funds during the period under review.

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12
Q

net current assets/ working capital equation

A

current assets- current liabilities

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13
Q

net capital employed equation

A

non-current liabilities + total share holder’s equity

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14
Q

what does liquidity assess?

A

whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due

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15
Q

give two ways to measure liquidity

A

the current ratio and the acid test ratio

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16
Q

the current ratio

A

-an effective measure for businesses that hold little stock
-quick way to measure liquidity and expressed as a ratio

17
Q

current ratio formula

A

current assets/ current liabilities
= ?:1

18
Q

the acid test ratio

A

-a precise way to measure it, expressed as a ratio
-important for businesses that hold a large amount of stock

19
Q

acid test ratio formula

A

(current assets - inventory) / current liabilities
= ? : 1

20
Q

why is cash flow management crucial?

A

to avoid cash flow problems, for example from customers paying late, having to pay suppliers early with not enough money to do so.

21
Q

how to improve liquidity?

A

-use cash flow forecasts to identify problems before they arise
-budget effectively and consider adopting zero budgeting to control spending
-set clear financial objectives and look to reduce costs and increase incomes where possible

22
Q

how can reducing credit period offered to customers improve liquidity?

A

-collecting money owed from customers faster increases the level of current assets
-customers may move to competing businesses that offer better credit terms however

23
Q

how can asking suppliers for an extended repayment period improve liquidity?

A

current liabilities will not be reduced
a company can hold onto its cash for a longer period before it needs to pay for goods or services. This helps to free up cash in the short term
-business can use cash for other purposes
-suppliers may be unwilling to extend credit terms

24
Q

how can using overdrafts or short term loans improve liquidity?

A

-current liabilities increase
-business can spend more money than it has available in account
-banks may not give money if they are having cash flow problems

25
how can selling off excess stock improve liquidity?
-less liquid current assets will be reduced and converted into more liquid forms of current asset -storage and security costs reduced -stock may need to be sold at a lower price however to attract fast sales
26
how can selling assets and leasing fixed assets instead improve liquidity?
-both current assets and liabilities will increase -the business will use assets but make regular payments to the leasing company
27
describe some common cash flow problems
low profits -cause of business failure, cannot pay bills- most important source of finance too much production capacity -spending too much on fixed assets excess inventory held -ties up cash, but -needs to be enough stock to meet demand and can be cheaper to bulk buy offering too much credit to customers -its a good way to build sales, however late payment is problematic seasonal demand -predictable changes in demand and cash flow -can be managed, but need to allow for seasonal changes overtrading -expanding too fast puts pressure on short term finance
28
working capital
the money that a business has to fund its day to day activities (net current assets)
29
working capital formula
current assets - current liabilities
30
why is cash the most liquid of a business's current assets?
it is immediately available for transactions, and can be used to settle debts immediately
31
how can working capital be managed
involves careful cash management -having less liquid debtors and inventory -convert current assets into cash as soon as possible -requesting extension of payment terms from suppliers -making use of short term borrowing options e.g. overdrafts, allows businesses to access more cash than it has in its current account
32
problems with a business having too much working capital
-if a business holds too much cash, it may be missing out on benefits of investing in fixed assets or investments -may represent an opportunity cost, if interest rates are high -holding too much inventory can incur extra storage costs