2.3.2 Liquidity (working capital for dec mock) Flashcards
define acid test ratio
assess whether or not a business has enough resources to meet any debts that arise in the next year, after stock has been sold
define assets
resources that belong to a business
define capital
money put into the business by the owners
define current assets
assets the business owns that will be converted into cash within a year
define current ratio
assesses whether or not a business has enough resources to meet any debts that arise in the next 12 months
define current liabilities
debts of the business which must be paid off within one year
define intangible assets
non-physical assets like brand names, patents
define inventories
stocks such as raw materials and finished goods held by the business
define liabilities
money owed by the business to banks and suppliers
define liquidity
the ease with which assets can be converted into cash
define net assets
total assets -total liabilities
define non current assets
long term resources that will be used repeatedly by the business over a period of time
define non current liabilities
money owed by the business for more than one year, e.g. mortgages
define shareholders equity
the amount of money owed by the business to the shareholders
define statement of financial position
aka balance sheet
a summary at a particular point in time of the value of a firm’s assets, liabilities and capital
define trade and other payables
money owed by the business to suppliers and utilities
define trade and other receivables
money owed to the business by customers and any prepayments made by the business
define working capital
the funds left over to meet day to day expenses after current debts have been paid
wc = c/Assets - c/Liabilities
is it true that in the statement of financial position, the value of assets = to value of liabilities and capital?
yes
as the resources purchased by a business have to be financed either from capital or liabilities
how do we calculate net assets?
subtracted the value of total liabilities from total assets
how do we calculate liquidity?
Acid test ratio
Current ratio
why is liquidity important to a business?
-need to cover short term debts -> b must have enough liquid resources to pay its immediate bills
formula for current ratio
CR = C Assents/C Liabilities
what is the ideal current ratio?
1.5:1 -2:1
shows the business has £1.50 of assets for every £1 of liabilities - can cover its short term debts
formula for Acid test ratio
AT = C/Assets - Inventory / C/Liabilities
what is the ideal acid test ratio
1:1 or more
as it is more severe
inventories are not treated as liquid stocks as not always can stock be sold -> therefore excluded
what is the working capital? (2 things)
the relativelt liquid assets of a business that can be turned into cash
-the money owed by a business which needs to be paid in the short term
formula for working capital
WC = C/Assets - C/Liabilities
what are some reasons for change in management of working capital?
size of business -> larger = inc in wc
debtors & creditors -> if the business has less debtors the smaller the wc
stock levels
how will a business maintain adequate levels of wc?
too little kept of wc -> trading problems
-too little stock of raw materials production may be halted
stocks are costly to keep
not enough cash -> cant pay bills on time
too much cash -> not earning high rates of interest
why is cash so important?
Cash is the most liquid of all business assets
-> it is the cash it keeps on the premises and money in the bank
- part of but not the same as working capital
- w/o cash business would fail to exist and can be the main reason for business failure
How can liquidity be improved?
-avoid through keeping tight control on financial resources
-overdraft facilities
-encourage cash sales and sell of stocks
reduce personal drawing from the business
negotiate additional loans
-introduce fresh capital -> imp cash flow
