P2- Hw 11 Liquidity Flashcards
Statement of financial position
Summary of the businesses finance showing their assets and liabilities
Liquidity
How easily a business can turn assets into cash
Current ratio
Shows a businesses ability to meet debts over the next year
Current ratio formula
Current ratio = current assets
————————
Current liabilities
Acid test ratio
Measures short term liquidity
Acid test ratio formula
current assets - stock
Acid test= ——————————
Current liabilities
Working capital
The day to day finance used in the business
(Aka net current assets)
Net current assets
The current assets — current liabilities
Capital employed
The total amount of capital used for the acquisition of profits by a business
Total equity
The value left in a company after subtracting the total liabilities from total assets
Cash vs profit
Cash- source of finance that can be easily accessed to pay for suppliers etc
Profit- the total capital left after costs have been taken away from sales revenue
Current asset
Something a business owns that can be turned into cash in less than a year
E.g. inventory/stock and cash
Current liability
Something the business owes that must be payed back within a year
W.g. Overdraft and trade credit
What is the ideal value for current ratio
1.5-2
• varies on type of business (fast food and banks have lower ratios but manufacturing have higher ratios)
Ideal value for acid test
0.75-1
• some businesses can operate lower than 1 as they trade mainly in cash
Why does acid test take away stock
It makes it more accurate as stock is considered less liquid than cash
Ways to improve liquidity
Raising more cash
Selling more non current assets
Agreeing to long term borrowing
Reducing short term borrowing
Working capital cycle
How a business gives a customer trade credit and a business gets trade credit from a supplier but if the customer doesn’t pay then the business can’t pay the supplier
