Liquidity (2.3.2)

Question 1

What does the statement of financial positions contain?

Answer 1

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

Question 2

What is the statement of financial positions also known as?

Answer 2

Balance Sheet

Question 3

What is Liquidity?

Answer 3

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

Question 4

What does Current Mean?

Answer 4

Short-Term (Next 12 Months)

Question 5

What does Non-Current mean?

Answer 5

Long-Term (Over a year)

Question 6

What is an asset?

Answer 6

Something the business owns (Cash, Machinery)

Question 7

What is Liability?

Answer 7

A debt that needs to be paid by the business

Question 8

What is a Current Asset? e.g.?

Answer 8

Asset that will be turned into cash in the next 12 months
e.g. Stock,Cash

Question 9

What is a Non-Current Asset? e.g.?

Answer 9

Assets the business aims to keep in the long-run
e.g. Warehouse

Question 10

What is Current Liability? e.g.?

Answer 10

Something the business owes in the next 12 months
e.g. Overdraft

Question 11

What is Non-Current Liability? e.g.?

Answer 11

Something the business owes in over a year
e.g. Mortgage

Question 12

What are the two ratios which measure the liquidity of a business?

Answer 12

-Current Ratio
-Acid Test Ratio

Question 13

What is Current Ratio?

Answer 13

Shows the ability of a business to meet their short-term debts

Question 14

What is the equation for Current Ratio?

Answer 14

Current Assets/Current Liabilities (Divide)

Question 15

What do each of the outcomes of Current Ratio mean?

Answer 15

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

Question 16

What is the Acid Test Ratio?

Answer 16

Shows the ability of a business to meet their short-term debts without having to sell inventory

Question 17

What is the equation for the Acid Test Ratio?

Answer 17

Current Assets-Inventory)/ Current Liabilities

Question 18

What do each of the outcomes of the Acid Test Ratio mean?

Answer 18

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

Question 19

What are the easy ways to improve liquidity?

Answer 19

-Sell Old Non-Current Assets
-Increase Share Capital
-Increase Long-Term Borrowing
-Postpone planned Investments

Question 20

What are the hard ways to improve liquidity?

Answer 20

-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

Question 21

What is the Importance of Liquidity?

Answer 21

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

Question 22

What is working capital?

Answer 22

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

Question 23

What is the Net Assets equation?

Answer 23

Total Assets-Total Liabilities