liquidity Flashcards
define liquidity
how easily assets can be converted into cash
what is a balance sheet?
a summary at a particular point in time of the value of a firms assets, liabilities and capital
what are assets
the resources currently owned by the business, like machinery, vehicles, stock and cash
what are liabilities?
debts of the business/what they owe, like a overdraft or a mortgage
define capital
the money put into the business by the owners, it is used to buy assets
non current assets
long term resouces that are used repeatedly over a period of time by the business, like land, equipment, vehicles
current assets
assets that will turn into cash within 12 months, they are liquid, these are things like inventories, prepayments etc
current liabilities
money owed by the business that must be repaid within a year, like loans, VAT and overdrafts
non current liabilities
long term loans and other money used by the business that does not have to be repaid within a year, like long term bank loans, mortages and pension funds
net assets
total assets - total liabilities
equal to shareholders equity at the bottom of a balance sheet
shareholders equity
summary of what the business owes
what can be used to measure liquidity?
current ratio and acid test ratio
current ratio
current assets/current liabilities
what does a current ratio need to be between or it to be good, or bad
between 1.5:1 and 2:1 is good
below 1.5 means the business doesn’t have enough working capital, meaning the business is overborrowing/overtrading
above 2:1 means too much money is tied up unecessrily, like stocks
why is acid test ratio more accurate than current ratio?
it takes into consideration inventory, which makes it more accurate
acid test ratio
current assets - inventories / current liabilities
what level is bad for acid test ratio?
less than 1:1 means its current assets do not cover its current liabilities
working capital
the amount of money needed to pay for day to day trading, like wages, electricity and gas charges
it is the amount left over after all current debts have been paid
working capital calculation
current assets - current liabilities
managing working capital
size of a business
size: the larger the business, the lareger the amount of working capital, and expanding businesses are likely to need lots of growing capital
managing working capital
maintaining adequate levels of working capital
- if a business doesn’t carry enough stock, it may be unable to fulfill orders in time
- not enough cash- can’t pay bills on time
- too much capitalm like excessive stock will cost more to physically store
ways to improve liquidity
- use of overfraft facilities
- negociate short term and long term loans
- reduce the amount of stock it holds
- sell/lease assets
- delay payment to suppliers
