Liquidity

Question 1

What’s a statement of financial position

Can also be called a balance sheet

Answer 1

They’re a snapshot of a firms finances at a fixed point in time

Question 2

What does a statement of financial position show

Answer 2

• Shows the value of all business’s assets and all its liabilities
• Also shows, the value of all the capital (money invested into the business) and source of capital (loans, shares, retained profits)

Question 3

What’s net assets

Answer 3

• Total current and non-current assets - total current and non-current liabilities
• Net assets value is always the same as total equity value- the total of all money that’s been put into the business.
  This is why they can be called balance sheets, as they balance

Question 4

Businesses can use capital to buy assets that’ll generate more revenue in the future

What’s this called

Answer 4

An investment

Question 5

What’s a non-current asset

Answer 5

Assets that the business is likely to keep for more than a year

E.g. property, land, production equipment, desks, computers

Question 6

What’s the total non-current assets value mean

Answer 6

The combined value of all business’s non-current assets

Question 7

What happens to non-current assets over time

Answer 7

Non-current assets lose value over time, as they become outdated or less reliable, so are worth less. This is depreciation

• Businesses should factor in depreciation to give realistic values of their non-current assets on the statement of financial position

Question 8

What are current assets

Answer 8

Assets that the business is likely to exchange for cash within the accounting year.

E.g. receivables, (money owed to the business by other businesses and individuals), inventory

• all current assets are added together to give the ‘total current assets’ value on the statement of financial position

Question 9

How do you get the figure for ‘net assets’ on the statement of financial position

Answer 9

• Current and non-current assets are added together

- Then current and non-current liabilities are deducted to give the figure for net assets

Question 10

What are liabilities

Answer 10

Debts that the business owes

Question 11

What are current liabilities

Answer 11

Debts which need to be paid off within a year

E.g. overdrafts, taxes, payables (money owed to creditors) and dividends

Question 12

How do you get ‘assets employed’

Answer 12

Total current liabilities are deducted from total non-current and current assets (net assets)

Question 13

What are non-current liabilities

Answer 13

Debts that the business will pay off over several years

E.g. mortgages and loans

Question 14

What are and debts

Answer 14

Debts that debtors won’t ever pay

Question 15

Why can’t bad debts be included on statement of financial position as an asset

Answer 15

Because the business isn’t going to get money for them

Question 16

Where does the business put these bad debts in terms of documents

Answer 16

On the statement of comprehensive income as an expense. Shows the business has lost money

Question 17

What is the liquidity of an asset

Answer 17

How easily the asset can be turned into cash

Question 18

Name a very liquid asset

Name an asset that’s not very liquid

Answer 18

• Cash is very liquid
• non-current assets such as factories are not liquid
• Inventory is not very liquid

Question 19

A business that doesn’t have enough current assets to pay its liabilities when they’re due is what

Answer 19

It’s insolvent

Question 20

How would a business overcome not having enough current assets to pay off its liabilities

Answer 20

• Either has to quickly find the money to pay them
• Ask creditors if it can pay its debts over a longer time period
• Or go into liquidation (cease trading and sell all of its assets to pay off its debts)

Question 21

How can liquidity be improved

Answer 21

• Decreasing stock levels
• Speeding up collection of debts owed to the business
• Slowing down payments to creditors (e.g. suppliers)

Question 22

What does it mean by how liquid a firm is

Answer 22

How able the firm is to pay off its short term debts (current liabilities)

Question 23

What does a liquidity ratio show

Answer 23

How liquid a firm is (how many current assets they have available to pay its current liabilities)

Question 24

What’s the formula for current ratio

What does it compare

Answer 24

Current assets / Current liabilities

• Compares current assets to current liabilities

Question 25

Current ratio should be higher than what

Answer 25

Should be higher than 1 (1.5:2) is considered ideal

Question 26

What does a value much below 1.5 suggest in a current ratio

Answer 26

Suggests a liquidity problem and that it might struggle to meet its current liabilities

Question 27

What does a value much higher than 2 suggest in a current ratio

Answer 27

Firm has more current assets than it needs

• the money tied up in these assets could be reinvested into the business to make more profit
• so a high ratio could put investors off as they’re not maximising their profits

Question 28

What’s the formula for acid test ratio

Answer 28

(Current assets - inventory) / current liabilities

Question 29

Why’s acid test ratio a tougher measure of liquidity than current ratio

Answer 29

As it accounts for inventory

Question 30

Why does removing inventory from current assets, result in giving a more accurate measure of the ability of a firm to pay its current liabilities (acid test ratio)

Answer 30

As inventory can take a long time to sell or it might not sell at all

Question 31

What does a high acid test ratio indicate

Answer 31

Indicate cash is lying idle in inventory rather than being reinvested to make profit

Question 32

Most businesses should have an acid test ratio higher than 1

However, who’s the exception

Answer 32

Businesses with a high stock turnover, such as supermarkets, might have a low acid test ratio and still survive as they can easily generate cash from their inventory which the acid test ratio ignores

Question 33

What’s working capital

Answer 33

The amount of cash (and assets that can easily be turned into cash) that’s the business has available to pay its day to day debts

• the more working capital a firm has, the more liquid it is

Question 34

Working capital is the same as net current assets

What’s the formula for this

Answer 34

Current assets - current liabilities

Question 35

Why can’t businesses survive if they don’t have enough working capital

Answer 35

Because they won’t be able to pay their debts when they’re due

Question 36

What’s the 4 stages in a working capital cycle

Answer 36

1) Cash
2) Production costs (wages, raw materials)
3) Finished stock
4) Sales (receivables)

Question 37

Describe the working capital cycle

Answer 37

It’s the length of time between buying raw materials and getting cash from sales of the finished product

Question 38

What does the length of the working capital cycle depend on

Answer 38

1) Nature of the product- how long it takes to produce and how long it’s held as stock
2) Credit periods the business gets from its suppliers and gives to its consumers- E.g. the shorter the period allowed to a consumer to pay for their goods the shorter the working capital cycle

Question 39

How much cash does a business need

Answer 39

Just enough to pay its current liabilities (short-term debts) but shouldn’t have too much cash

• spare cash is great at paying off debts, but lousy at earning money for the business

Question 40

What factors affect how much cash a business needs

Answer 40

• A firm with a long working capital cycle needs more cash than a business with a shorter cycle, as it has to wait longer for money to come in
• More Cash needed when inflation is high to cover higher wages and buying and holding stock
• When a business expands, to avoid overtrading. (Avoid not being able to pay suppliers due to increased amount supplied)