2.3.2- Liquidity

Question 1

Balance sheet

Answer 1

• document showing a business’ assets and liabilities
• snapshot of what a business is worth at a particular time
• useful for shareholders, suppliers and lenders to judge the financial position of a business
• also shows the source of funds

Question 2

Assets

Answer 2

Current:

• short term
• planned to be turned into cash within the coming year
• includes inventories and other receivables who owe money to the business

Non Current:

• long term
• not expected to be turned into cash within a year
• intangible assets maybe copyrights, patents and trademarks
• tangible assets include property, equipment and machinery

Question 3

Liabilities

Answer 3

Current:

• debts expected to be paid within the next year
• includes borrowings (short term loans) and overdrafts

Non current:

• debts not expected to be paid off within a year
• long term borrowings
• provision for liabilities is money set aside for future expenses

Question 4

Equity

Answer 4

Money owed to the shareholders of a company

ordinary shares- amount of money paid by shareholders for shares when originally issued

share premium- difference between share price and nominal value

accumulated losses- loses from the previous years trading and decrease the value of equity

Question 5

Uses of a balance sheet

Answer 5

• evaluate performance of a business
• evaluate potential of a business to an investor
• summary of valuation of a business

Question 6

Limitations of a balance sheet

Answer 6

• value of assets may not be the same as the amount they will sell for
• intangible may include goodwill, which is hard to value
• static snapshot. everything may change tomo

Question 7

Measuring Liquidity

Answer 7

• ability of a business to turn its assets into cash

- cash is the most liquid asset of them all

Question 8

What does liquidity tell us?

Answer 8

• demonstrates the ability of a firm to pay its debts

- banks, suppliers and investors will all be interested in the liquidity

Question 9

Current Ratio formula

Answer 9

current assets/ current liabilities
-between 1.5:1 and 2:1 = business has plenty of working capital to pay its day-to-day bills
>2:1 = too much money tied up in assets that aren’t making enough money
<1.5:1 = maybe an issue, however retail stores operate at 1:1 as they have fast moving stocks and generate cash from sales

Question 10

Acid Ratio Formula

Answer 10

current assets- stocks/ current liabilities
-harsher test of liquidity because you can’t guarantee to sell all stocks

> 1:1 = business cannot cover it’s current liabilities

some retailers have a strong cash flow and fast moving stocks may have an acid test of 0.4:1

Question 11

Ways of improving liquidity

Answer 11

• reducing the amount of goods the firm holds, so there is a faster dispatch time to consumers
• reduce trade credit periods
• pay suppliers later on agreed credit terms
• increase long term borrowing to reduce short term borrowing

Question 12

Working Capital

Answer 12

• funds that a business has to meet its day to day expenses

- formula = current assets- current liabilities