2.3.2 Liquidity

Question 1

statement of financial position
(balance sheet)
2 things

Answer 1

• net worth of a business (records assets/liabilities)

- raised capital & used capital

Question 2

two sides of a balance sheet

Answer 2

NET ASSETS:
(Non current assets + Current assets - Current liabilities- Non current liabilities)

TOTAL EQUITY
Share capital + Reserves (retained profit over years)

Question 3

net assets

Answer 3

must equal total equity (both figures must be balanced)

Question 4

non-current and current assets

Answer 4

NON-CURRENRT: own long time
e.g land, building, plant, property, equipment, machinery, goodwill/other tangibles (customer base) and brand name

CURRENT: (quick and easy to turn into cash)
e.g. cash balances/cash equivalent, trade debtors (receivables), inventories (stock), short term investment

Question 5

current and non-current liabilities

examples

Answer 5

CURRENT: debt must be paid within year
e.g. trade creditors (payables), overdraft, tax, ST loan

NON-CURRENT:
e.g long term borrowings/liabilities (loan/mortage)

Question 6

creditor and debtors

Answer 6

creditor = payables

debtor = receivables

Question 7

3 accounts

Answer 7

statement of comprehensive income (PAST)
statement of financial position (PRESENT)
cash flow forecast (FUTURE)

Question 8

net assets equation (also working capital)

Answer 8

non current assets + (current assets - current liabilities) - non current liabilities

Question 9

working capital (net current assets)

Answer 9

-net current assets
-day to day finance (funds to meet business needs)
-cash moving through cycle = enough for future
-measure of liquidity
current assets - current liabilities

Question 10

total equity

Answer 10

total amount of money invested in business from share capital and retained profit

share capital + retained profit

Question 11

least liquid current asset

Answer 11

in statement of financial position = inventories

liquid = turn to cash

-commenting on business liquidity position = look at net current assets

Question 12

goodwill

Answer 12

reputation for good quality included as good will in intangible assets

Question 13

equity capital

Answer 13

share capital and retained earnings

Question 14

interpreting statement of financial position

3 things

Answer 14

• short term net current assets
• each section
• compare borrowed money with equity

Question 15

liquidity ratios

Answer 15

able to meet its short term liabilities & debts

• business’ cash position (pay bills?)
• making profit but unable to pay bills

1. current ratio
2. acid test

Question 16

current ratio

Answer 16

ability to meet debts over next year

current assets divided by current liabilities

ideal value 1.5:1
-varies on types of business
(fast food/banks = lower, deal in cash) (manufacture higher = lots of stock)

Question 17

acid test

Answer 17

very short term liquidity
-more accurate indicator
inventories = less liquid than cash

current assets - stock divided by current liabilities

ideal values 1:1 larger than 1 as trade mainly in cash.

Question 18

problems with liquidity

high and low

Answer 18

• low = risk from insolvency

- high = X adv of possible inv opportunities

Question 19

if liquidity ratio is low?

Answer 19

• hard to pay bills

- bring more cash into balance sheet

Question 20

measure of liquidity

Answer 20

ability to convert an asset into any form usually cash without any delay

Question 21

5 stages of liquidity cycle/working capital cycle

Answer 21

1. capital injection
2. produce goods
3. sell to customers (credit or cash) (if credit = delay)
4. customers pay (receivables) (delay if dont pay on time)
5. buy materials (delayed if given trade credit)

Question 22

3 reasons why working capital is important to a business?

different businesses

Answer 22

1-day to day, machines/stock etc
2-pay wages/bills
3-long working capital cycle= incur costs (unpredictable)

• small business: large firms delay = limited funds
• expand business: expenditure = working capital

Question 23

5 causes of working capital problems

Answer 23

1-external/internal changes
2-high start costs,expansion/extra orders (quickly)
3-customers credit but supplier not giving credit
4-too much stock/failing to control levels
5-poor control of creditors and debtors

Question 24

6 ways to improve working capital

Answer 24

1-uncertainty
2-minimise fixed assets
3-minimise stock (effective management)
4-customer credit low much credit from suppliers (goods quicker = quicker payments)
5-cut production costs, sale &leaseback/ redundant asset
6-negotiate additional short term loans (financial planning)

Question 25

liquidity

Answer 25

ability of a business to find cash needed to pay bills

Question 26

working capital

Answer 26

current assets - current liabilities

Question 27

5 ways to improve liquidity

Answer 27

1. sell under used fixed assets (sell and lease back)
2. raise more share capital (cash)
3. increase long term borrowings (reduce CL/loans)
4. postpone planned investment
5. reduce customer trade credit & increase own