Liquidity analysis

Question 1

Define liquidity

Answer 1

Liquidity describes the ability of a business to pay off its short-term debts as they are all due, given it can convert its current assets into cash.

Question 2

Define “working capital.”

Answer 2

Working capital shows the liquid funds owned by a business, displaying their short-term liquidity.
Working capital works under the theory that if the current Assets of a business exceed the current liabilities, then that business is in a liquid position where they can pay off their short-term debts that’ll fall due within the next 12 months.

Question 3

List some negative factors of a high working capital ratio.

Answer 3

: This may mean that a business has an excessive amount of funds tied up in inventory, resulting from a low level of sales.
: This may mean a business has an excessive amount of funds tied up in accounts receivable, which may indicate a slow accounts receivable turnover, being a negative sign in a business.

Question 4

Define “quick Asset ratio.”

Answer 4

The Quick Asset ratio of a business measures its immediate liquidity, which is the ability of a business to pay off highly urgent debts that cannot wait for 12 months. Hence, it’s calculated in the same way as Working ratio, only that it discludes inventory and prepaid expenses

Question 5

Define “Cash flow cover.”

Answer 5

The “Cash flow cover,” of a business shows how many times the net cash flows from a business’s operating activities can be expected to cover that business’s current liabilities. Thus, this figure aims to show whether a business has sufficient coverage over its current liabilities.