Liquidity

Question 1

What is liquidity

Answer 1

A company’s ability to convert assets to cash or acquire cash—through a loan or money in the bank—to pay its short-term obligations or liabilities.

Question 2

Non-current assets

Answer 2

Long term assets that cannot be quickly converted into cash
Eg a factory

Question 3

How can liquidity be improved?

Answer 3

Decreasing stock levels
Speeding up the collection of debts owed to the business
Slowing down payments to suppliers

Question 4

Accounting ratio

Answer 4

Also known as a liquidity ratio
Shows how liquid a firm is (how able they are to pay their short term debts)

Question 5

Current ratio formula

Answer 5

Current ratio= Current assets/current liabilities

Question 6

Current Ratio

Answer 6

The current ratio should be higher than 1 to replace inventory
A 1.5 to 2 is considered ideal
A value higher than 2 suggests that the firm, has more current assets than it needs. The money tied up could be used to reinvest in the business and increase profit
This would suggest the business isn’t focused on maximising profit

Question 7

Acid Test Ratio formula

Answer 7

Acid test ratio= (Current assets - inventory) / current liabilities

Question 8

Acid Test Ratio

Answer 8

Also known as liquid capital ratio
Accounts for the inventory
Inventory can take a long time to sell or may not sell at all
By removing inventory from current assets, the acid test gives more of an accurate measure of the ability for the firm to pay its current liabilities

Ideal to have an ATR higher than 1 but some businesses can survive with it being low
A high ATR indicates cash is sitting idle rather than being reinvested.

Question 9

Working Capital

Answer 9

The amount of cash the business has available to pay day to day debts

Question 10

Working Capital cycle

Answer 10

Cash -> Production costs -> Finished stock -> Sales -> Cash
The length of time between buying raw materials and getting cash from sales of the finished product. Usually measured in days

Question 11

Working capital formula

Answer 11

Working capital= Current assets - Current liabilities

Question 12

Factors which affect how much cash a business needs

Answer 12

A business with a long working capital cycle needs more cash as it waits ,longer for cash to come in
Inflation increases the cost of wages and buying/ holding stock so may need more cash
When a business expands it needs more cash to avoid over trading (Can pay suppliers)