liquidity Flashcards
what is liquidity?
the ability of a business to meet its short term commitments with its available assets
what happens to a business that cannot pay its bills?
usually fails rapidly even if they are profitable
why is managing liquidity important?
it helps manage risk and enables them to prepare for the unexpected
what does the statement of financial position show?
the financial structure of a business at a specific point in time
what are the two things the statement of financial position show?
assets and liabilities whilst specifying the capital used to fund the business
what is the statement of financial possession also known as?
the Balance Sheet
what is a non-current asset?
items that are owned by a business for the long-term (e.g machinery and buildings)
what is a current asset?
items that are converted to cash quickly - usually within 12 months (e.g cash and inventory)
what are current liabilities?
money a business owes and is due to be settled soon - usually within 12 months (e.g trade payables and short-term borrowings)
what are non-current liabilities?
money a business owes and that does not need to be paid back for at least 12 months e.g bank loans and mortgages
how do you calculate the net assets?
assets - liabilities
what does the Balance sheet show?
how the net assets of a business are funded
what are net assets the same as?
capital employed
what are the two ways to measure liquidity?
current ration and acid test ratio
what is the current ratio?
a quick way to measure liquidity
what is the current ratio expressed a?
a ratio E.g 0.1:1
what type of business is the current ratio to most effective for when measuring liquidity?
those that hold little stock
what does the result of the current ratio show?
how many £s of current assets it has available to cover each £1 of short term debt
how do you calculate the current ratio?
current assets / current liabilities
what is the acid test ratio?
a precise way to measure liquidity
what is the acid test ratio also known as?
liquid capital ratio
how is the acid test ratio calculated?
(current assets - inventory) / current liabilities
how can you improve liquidity?
to manage the business better
how can you manage a business better?
use a cashflow forecast to identify potential cash flow issue, budget effectively and set clear financial objectives
what is a cashflow forecast?
a prediction of future cash inflows and outflows
what is zero budgeting?
budgeting that starts with zero and then each item requested by a department has to be justified
how does reducing the credit period offered by customers improve liquidity?
it will increase the level of current assets in the business
how does asking suppliers for an extended repayment period improve liquidity?
current liabilities will not be reduced, the business can use cash it would have paid to suppliers for other purposes
how can making use of an overdraft improve liquidity?
the business can spend the business can spend more money than it has in its bank account
how can selling off excess tock improve liquidity?
less liquid current assets will be reduced and converted into more liquid forms of current assets (e.g cash)
how can selling and leasing fixed assets improve liquidity?
the business will continue to have the use of assets but must make regular payments to the leasing company
what is working capital?
the money that a business has to fund its day to day activities
what is working capital often describes as on a balance sheet?
net current assets
how do you calculate the working capital?
current assets - current liabilities
what is the most liquid current asset?
cash
