Liquidity Flashcards
What is the statement of financial postition (balance sheet)
A document which provides the summary of a business’s assets, liabilites and capital
What are assets?
Resources owned by business to make products/services eg building, machinery, equipment
What are liabilities?
debts of a business short/long term
What is capital?
The money put into the business by the owners along with other sources of finance used to buy assets
Formula for assets?
capital + Liabilities
What are non current assets?
long term resources that would be used repeatedly by the business over a period of time
EG fixed assets, intangible assets
Examples of non current assets?
-land
-property
-equipment
Examples of intangible assets?
Non physical assets:
-customer lists
-trademark of their brand name
-brand names
What are current assets?
liquid Assets. Assets that the business expects to use or sell within a year. These can be converted into cash to pay off liabilities
What does it mean by the liquidity of an asset?
How easily it can be turned into cash
What are current liabilites?
Any money owed by a business that must be repaid within one year eg loans, tax liabilites, payables
What are non current liabilites?
Long term loans and any money owed which would take more than 1 year to repay eg long term bank loans, mortgages
What are net assets?
calculates by doing total assets- total liabilities
What is shareholders equity?
Provides a summary of what is owed to the owners of the business eg share captial, retained profit
How is liquidity measured?
Through info on a balance sheet
a)What does liquidity measure?
b)what are the two financial ratios to measure liquidity?
a)the businesses ability to pay off its short term debts with its liquid resources
b)current ratio and acid test ratio
Formula for current ratio:
current assets/current liabilities
Formula for acid test ratio:
(current assets-inventories)/current liabilites
What is considered a sufficient current ratio?
1.5:1 and 2:1
This suggests that every £2/£1.50 of current assets for every £1 of current liabilites
What is identified if the current ratio is below 1.5?
the business has not enough working capital=business may be overborrowing/overtrading
Why may some business have a current ratio below 1 and be okay?
as they have fast selling stock and generate cash form sales eg supermarkets, retailers
What is identified if the current ratio is above 2?
Too much money is tied up unproductively eg stock
What is the acid test ratio?
similar to current ratio but excludes stocks from current assets. A more severe test of liquidity
Why is stock excluded from the acid test ratio measure to make it more accurate?
as there is no guarantee that stock will be sold as they may become obsolete or deteriorate
What does it mean if you have an acid test ratio of less than 1?
you dont have enough current assets to pay for your current liabilities
-however some retailers with strong cash flow may operate comfortably
What is working capital?
The funds left over to meet the day to day expenses (wages, electricity) after current debts have been paid for
What is the formula for working capital?
current assets-current liabilites
low levels signifies struggle and close to closure
What happens when current assets are too low and current liabilites are too high?
- not be able to pay bills
-production is halted if stock is not enough=unfulfilling orders
-not able to pay trade creditors=bad relationship
What happens when current assets are too high and current liabilites are too low?
-too much stock=money tied up in stock and expensive to keep which could be spent on reducing borrowing and interest
-too much cash which would be used to pay back debts or invest
What does managing working capital depend on?
-size of business (large=more capital)
-stock levels (diff industries need diff levels)
-debtors and creditors
Why is cash the most important aspect to the running of a business?
without cash businesses fail
What are ways to improve liquidity?
-negotiate short term or long term finance
-encourage cash sales and sell of stocks (discounts)
-extend credit with selected suppliers
-use an overdraft facility (negotiate with banks)
Why is cash flow and working capital different?
example:
-cash flow soultion=borrowing, although debt means not working capitak solution
solution for both: borrowing more in long term
What can a balance sheet be used to measure?
liquidity ratios, gearing ratios and efficiency ratios
