2.3.2. Liquidity Flashcards
Balance Sheet:
Document that shows what a business owns ( assets) and what it owes ( liabilities).
Snapshot of what a business is worth at a particular time
Shareholders,lenders + suppliers use it to judge financial position of business
Shows source of funds + use of funds in the business
Also knows as statement of financial position
PLCs + sole traders have to publish by law
On a balance sheet assets always = liabilities
Equation for assets=
Liabilities + equity
1) Assets:
2) Liabilities:
3) Capital:
4) Assets=
1) resources owned by a business e.g. equipment, stock
2) debts of a business/ what they owe ( external source of finance)
3) money put into business by owners + others
Assets =. Capital + liabilities
Non current assets:
( intangible assets, deferred tax assets, property,plant + equipment)
- The long term assets of a business which are not expected to be sold within the next year of trading
• Intangible assets : copyright, patents,
trademarks, goodwill
• Tangible assets are; property, plant and equipment which might be factory machinery to
make the chocolates
• Deferred tax assets : the payment of taxes
Current Assets:
( inventories, trade and other receivables, cash and cash equivalents)
- short term assets of the business which are likely to be turned into cash within the
next year of trading
• Inventories : stocks of raw materials (coca beans), finished goods and work-in-progress
• Trade and other receivables : trade debtors
who owe money to the business. Most business
runs on trade credit so this figure is not a worry.
• Cash : cash at bank held by the business
Non - current liabilities:
( borrowings, retirement benefit obligations, provision for liabilities, other )
- debts which are not expected to be paid off within the next year of trading
• Borrowings : long term (over 1 year) loans
• Retirement benefit obligations : money owed to past employees in pensions
• Provision for liabilities : money set aside for expenses in the future
• Other non-current liabilities : might be money to pay for repairs to machinery
Current Liabilities:
( trade+ other payables, borrowings, current tax liabilities, provisions for liabilities)
- debts which are expected to be paid in the next year of trading
• Borrowings : short term loans (less than a year) and overdrafts
• Current tax liabilities : corporation tax
• Provision for liabilities : money set aside to pay
Net Assets:
Total liabilities - total assets
- will be = to shareholders equity at bottom of balance sheet
Equity:
Money owed to shareholders
Ordinary shares:
Amount of money paid by shareholders for shares when originally issued
Share premium:
Difference between share price + nominal value
Accumulated losses:
Losses from previous years trading + decrease the value of the equity
Uses Of balance sheet:
Limitations of balance sheet:
+ to evaluate performance of business
+ to evaluate potential of business to an investor
+ summary of business
- value of assets state may not be same as amountbthyell sell for
- intangible may include goodwill which is hard to put a value on
- balance sheet= only a snapshot of 1 day , picture could change
Liquidity
The ability of a business to turn its assets into cash
Least liquid assets = top
Cash is the most liquid asset of all
What does liquidity tell us about a business?
- indicates to an investor the ability of the business to pay its debts
- Banks and investors may be interested in liquidity to see if the business has enough resources to pay its debts
- Creditors (suppliers) may be interested in the
liquidity of the business to see if they will receive
the money they are owed
Current Ratio- To measure liquidity
Current assets
————————-
Current liabilities
1.5:1- 2:1 = business has plenty of working capital to meet its day to day bills
Above 2:1 = too much money tied up in assets that aren’t making money
Below 1.5:1 = could be a problem but many stores operate at 1:1 as they have fast moving stocks and generate cash from sales
Acid ratio test - to measure liquidity
( quick ratio )
Current assets - stock
———————————
Current liabilities
- can’t guarantee to sell all stock
- less than 1:1 then current assets - stock don’t cover current liabilities
( Could indicate a problem) - some retailers with strong cash flow may have acid test 0.4:1 and be fine
Ways to improve liquidity:
- reduce amount of stock so finished goods need to be dispatched faster to customers
- business could reduce credit period
- business could pay suppliers later on agreed credit terms
- increase borrowing long term + clear short term debts
Working capital:
(Current assets- current liabilities)
- this is the funds that a business has to meet its day-to-day expenses
- very low= business is in trouble+ has issues paying expenses
- time lag between customer paying for goods + supplier wanting payment that isn’t. In favour of the business
- can cause shortage of working capital
