Liquidity (2.3.2) Flashcards
What does the statement of financial positions contain?
Contains the financial information required to draw conclusions about the liquidity of the business. Shows the financial structure of a business at a specific point in time and identifies the business’s assets and liabilities
What is the statement of financial positions also known as?
Balance Sheet
What is Liquidity?
The ease in which assets can be turned into cash to pay bills within the next 12 months. A business that can’t pay its bills will usually fail very quickly, even if they are profitable
What does Current Mean?
Short-Term (Next 12 Months)
What does Non-Current mean?
Long-Term (Over a year)
What is an asset?
Something the business owns (Cash, Machinery)
What is Liability?
A debt that needs to be paid by the business
What is a Current Asset? e.g.?
Asset that will be turned into cash in the next 12 months
e.g. Stock,Cash
What is a Non-Current Asset? e.g.?
Assets the business aims to keep in the long-run
e.g. Warehouse
What is Current Liability? e.g.?
Something the business owes in the next 12 months
e.g. Overdraft
What is Non-Current Liability? e.g.?
Something the business owes in over a year
e.g. Mortgage
What are the two ratios which measure the liquidity of a business?
-Current Ratio
-Acid Test Ratio
What is Current Ratio?
Shows the ability of a business to meet their short-term debts
What is the equation for Current Ratio?
Current Assets/Current Liabilities (Divide)
What do each of the outcomes of Current Ratio mean?
Less than 1 = The firm cant pay its short-term debts
1.0=The firm can just about pay its short-term debts
1.2-2.0= The firm can comfortably pay its short-term debts
2.5+=The firm is potentially too liquid
What is the Acid Test Ratio?
Shows the ability of a business to meet their short-term debts without having to sell inventory
What is the equation for the Acid Test Ratio?
Current Assets-Inventory)/ Current Liabilities
What do each of the outcomes of the Acid Test Ratio mean?
Less than 1=The firm has to sell stock to pay short-term debts
1.0=the firm can just about pay its short-term debts without selling stock
1.5=The firm can comfortably pay its short-term debts without selling stock
2.0+=The firm is potentially too liquid
What are the easy ways to improve liquidity?
-Sell Old Non-Current Assets
-Increase Share Capital
-Increase Long-Term Borrowing
-Postpone planned Investments
What are the hard ways to improve liquidity?
-Minimize stock levels
-Reduce payment Terms for Customers (have to pay quicker)
-Increase payment Terms with Suppliers (get longer to pay suppliers)
-Get products to market quickly
-Reduce Fixed Costs
What is the Importance of Liquidity?
You need cash to survive especially if..
-Demand isn’t consistent
-Market is Dynamic
-Products aren’t ready for the market
-Outgoings aren’t stable
What is working capital?
Is the money that a business has to fund its day to day activities. Its often described as net current assets on the statement of financial position
What is the Net Assets equation?
Total Assets-Total Liabilities
