2.3.2 Liquidity (working capital for dec mock)

Question 1

define acid test ratio

Answer 1

assess whether or not a business has enough resources to meet any debts that arise in the next year, after stock has been sold

Question 2

define assets

Answer 2

resources that belong to a business

Question 3

define capital

Answer 3

money put into the business by the owners

Question 4

define current assets

Answer 4

assets the business owns that will be converted into cash within a year

Question 5

define current ratio

Answer 5

assesses whether or not a business has enough resources to meet any debts that arise in the next 12 months

Question 6

define current liabilities

Answer 6

debts of the business which must be paid off within one year

Question 7

define intangible assets

Answer 7

non-physical assets like brand names, patents

Question 8

define inventories

Answer 8

stocks such as raw materials and finished goods held by the business

Question 9

define liabilities

Answer 9

money owed by the business to banks and suppliers

Question 10

define liquidity

Answer 10

the ease with which assets can be converted into cash

Question 11

define net assets

Answer 11

total assets -total liabilities

Question 12

define non current assets

Answer 12

long term resources that will be used repeatedly by the business over a period of time

Question 13

define non current liabilities

Answer 13

money owed by the business for more than one year, e.g. mortgages

Question 14

define shareholders equity

Answer 14

the amount of money owed by the business to the shareholders

Question 15

define statement of financial position

Answer 15

aka balance sheet
a summary at a particular point in time of the value of a firm’s assets, liabilities and capital

Question 16

define trade and other payables

Answer 16

money owed by the business to suppliers and utilities

Question 17

define trade and other receivables

Answer 17

money owed to the business by customers and any prepayments made by the business

Question 18

define working capital

Answer 18

the funds left over to meet day to day expenses after current debts have been paid
wc = c/Assets - c/Liabilities

Question 19

is it true that in the statement of financial position, the value of assets = to value of liabilities and capital?

Answer 19

yes
as the resources purchased by a business have to be financed either from capital or liabilities

Question 20

how do we calculate net assets?

Answer 20

subtracted the value of total liabilities from total assets

Question 21

how do we calculate liquidity?

Answer 21

Acid test ratio
Current ratio

Question 22

why is liquidity important to a business?

Answer 22

-need to cover short term debts -> b must have enough liquid resources to pay its immediate bills

Question 23

formula for current ratio

Answer 23

CR = C Assents/C Liabilities

Question 24

what is the ideal current ratio?

Answer 24

1.5:1 -2:1
shows the business has £1.50 of assets for every £1 of liabilities - can cover its short term debts

Question 25

formula for Acid test ratio

Answer 25

AT = C/Assets - Inventory / C/Liabilities

Question 26

what is the ideal acid test ratio

Answer 26

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

Question 27

what is the working capital? (2 things)

Answer 27

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

Question 28

formula for working capital

Answer 28

WC = C/Assets - C/Liabilities

Question 29

what are some reasons for change in management of working capital?

Answer 29

size of business -> larger = inc in wc
debtors & creditors -> if the business has less debtors the smaller the wc
stock levels

Question 30

how will a business maintain adequate levels of wc?

Answer 30

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

Question 31

why is cash so important?

Answer 31

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

Question 32

How can liquidity be improved?

Answer 32

-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