Liquidity

Question 1

What is the statement of financial postition (balance sheet)

Answer 1

A document which provides the summary of a business’s assets, liabilites and capital

Question 2

What are assets?

Answer 2

Resources owned by business to make products/services eg building, machinery, equipment

Question 3

What are liabilities?

Answer 3

debts of a business short/long term

Question 4

What is capital?

Answer 4

The money put into the business by the owners along with other sources of finance used to buy assets

Question 5

Formula for assets?

Answer 5

capital + Liabilities

Question 6

What are non current assets?

Answer 6

long term resources that would be used repeatedly by the business over a period of time
EG fixed assets, intangible assets

Question 7

Examples of non current assets?

Answer 7

-land
-property
-equipment

Question 8

Examples of intangible assets?

Answer 8

Non physical assets:
-customer lists
-trademark of their brand name
-brand names

Question 9

What are current assets?

Answer 9

liquid Assets. Assets that the business expects to use or sell within a year. These can be converted into cash to pay off liabilities

Question 10

What does it mean by the liquidity of an asset?

Answer 10

How easily it can be turned into cash

Question 11

What are current liabilites?

Answer 11

Any money owed by a business that must be repaid within one year eg loans, tax liabilites, payables

Question 12

What are non current liabilites?

Answer 12

Long term loans and any money owed which would take more than 1 year to repay eg long term bank loans, mortgages

Question 13

What are net assets?

Answer 13

calculates by doing total assets- total liabilities

Question 14

What is shareholders equity?

Answer 14

Provides a summary of what is owed to the owners of the business eg share captial, retained profit

Question 15

How is liquidity measured?

Answer 15

Through info on a balance sheet

Question 16

a)What does liquidity measure?

b)what are the two financial ratios to measure liquidity?

Answer 16

a)the businesses ability to pay off its short term debts with its liquid resources

b)current ratio and acid test ratio

Question 17

Formula for current ratio:

Answer 17

current assets/current liabilities

Question 18

Formula for acid test ratio:

Answer 18

(current assets-inventories)/current liabilites

Question 19

What is considered a sufficient current ratio?

Answer 19

1.5:1 and 2:1
This suggests that every £2/£1.50 of current assets for every £1 of current liabilites

Question 20

What is identified if the current ratio is below 1.5?

Answer 20

the business has not enough working capital=business may be overborrowing/overtrading

Question 21

Why may some business have a current ratio below 1 and be okay?

Answer 21

as they have fast selling stock and generate cash form sales eg supermarkets, retailers

Question 22

What is identified if the current ratio is above 2?

Answer 22

Too much money is tied up unproductively eg stock

Question 23

What is the acid test ratio?

Answer 23

similar to current ratio but excludes stocks from current assets. A more severe test of liquidity

Question 24

Why is stock excluded from the acid test ratio measure to make it more accurate?

Answer 24

as there is no guarantee that stock will be sold as they may become obsolete or deteriorate

Question 25

What does it mean if you have an acid test ratio of less than 1?

Answer 25

you dont have enough current assets to pay for your current liabilities

-however some retailers with strong cash flow may operate comfortably

Question 26

What is working capital?

Answer 26

The funds left over to meet the day to day expenses (wages, electricity) after current debts have been paid for

Question 27

What is the formula for working capital?

Answer 27

current assets-current liabilites

low levels signifies struggle and close to closure

Question 28

What happens when current assets are too low and current liabilites are too high?

Answer 28

• not be able to pay bills
  -production is halted if stock is not enough=unfulfilling orders
  -not able to pay trade creditors=bad relationship

Question 29

What happens when current assets are too high and current liabilites are too low?

Answer 29

-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

Question 30

What does managing working capital depend on?

Answer 30

-size of business (large=more capital)
-stock levels (diff industries need diff levels)
-debtors and creditors

Question 31

Why is cash the most important aspect to the running of a business?

Answer 31

without cash businesses fail

Question 32

What are ways to improve liquidity?

Answer 32

-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)

Question 33

Why is cash flow and working capital different?

Answer 33

example:
-cash flow soultion=borrowing, although debt means not working capitak solution

solution for both: borrowing more in long term

Question 34

What can a balance sheet be used to measure?

Answer 34

liquidity ratios, gearing ratios and efficiency ratios