Liquidity

Question 1

Define STATEMENT OF FINANCIAL POSITION

Answer 1

A statement of financial position is a document providing a snapshot of a business’ assets, liabilities and net worth at a specific point in time. Shows where major sources of finance have come from and how the business spends what it has raised.

Question 2

Define an ASSET

Answer 2

Assets are items of value owned by the business. There can be current and non current assets.

Question 3

Define a LIABILITY

Answer 3

A liability is something the the business owes. There are two types: current and non current liabilities.

Question 4

Define CAPITAL

Answer 4

Capital is money put into the business. It can come from shareholders (known as equity) or from previous profits (reinvested profits).

Question 5

Define LIQUIDITY

Answer 5

Liquidity is a measure of a firm’s ability to meet short term debts and day to day expenses.

Question 6

Define a LIQUID ASSET

Answer 6

Liquid assets are the businesses total assets minus the assets that exist as stock.

Question 7

How is the current ratio calculated?

Answer 7

Current ratio = Current assets/current liabilities

Question 8

How is the acid test ratio calculated?

Answer 8

Acid test ratio = liquid assets/current liabilities.

Question 9

Interpret the current ratio and acid test ratio values

Answer 9

A value between 1.5 and 2 suggests efficient management of working capital. A value significantly below one suggests there is cash flow problems. A value that is over 2 suggests there is working capital that could be used elsewhere.

Question 10

Define WORKING CAPITAL

Answer 10

Working capital is the amount of money needed to pay for day to day expenses of the business.

Question 11

What is the working capital cycle?

Answer 11

Inventories ordered from the supplier - production turned inventory into products - finished good is held until a customer is found - products sol to customers - customers pay for their expenses

Question 12

What are the main causes of cash flow problems?

Answer 12

• Low profits/losses
• Too much rproduction capacity
• Excess stock held
• Allowing customers too much credit
• Overtrading
• Unexpected changes
• Seasonal demand

Question 13

How can a business improve its cash position?

Answer 13

• Reduce current assets
• Increase current liabilities
• Sell surplus fixed asset
• Increase equity finance
• Increase long term liabilities
• Cut back on planned investments