2.3.2 : Liquidity Flashcards
(21 cards)
What is an income statement ?
This measures the business’ performance over a given period of time, usually one year. It compares the income of the business against the cost of goods or services and expenses incurred in earning that revenue
What is a statement of financial position ?
This is a snapshot of the business’ assets (what it owns or is owed) and its liabilities (what it owes) on a
particular day - usually the last day of the financial year
What is a cash flow statement ?
This shows how the business has generated and disposed of cash and liquid funds during the period
under review
What is a balance sheet ?
This is a snapshot of the business’ assets (what it owns or is owed) and its liabilities (what it owes) on a
particular day - usually the last day of a financial period
What is a liquidity ratio ?
Assess whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due
How do you evaluate a current ratio ?
Interpreting the results
– Ratio of 1.5-2.0 would suggest efficient management of working capital
– Low ratio (e.g. below 1) indicates cash problems
– High ratio: too much working capital?
What are the main causes of cash-flow problems ?
• Low profits or (worse) losses
• Too much production capacity
• Excess inventories held
• Allowing customers too much credit & too long to pay
• Overtrading – growing the business too fast
• Unexpected changes in the business
• Seasonal demand
What are the problems of spending on capacity ?
• Spending too much on fixed assets
• Made worse if short-term finance is used (e.g. bank overdraft)
• Fixed assets are hard to turn back into cash in the short-term
What are the problems of too much stock ?
• Excess stocks tie up cash
• Increased risk that stocks become obsolete
• But…
• There needs to be enough stock to meet demand
• Bulk buying may mean lower purchase prices
What are the problems with allowing customers too much credit ?
Customers who buy on credit are called “trade debtors”
• Offer credit = good way of building sales
• But…
• Late payment is a common problem
• Worse still, the debt may go bad
What is overtrading ?
Where a business expands too quickly, putting pressure on short-term finance
How do you mange cash flow problems ?
Make and action reliable cash flow forecasting
Manage working capital effectively
Choose the right sources of finance
What are debtors ?
Amounts owed by customers
What are creditors ?
Amounts owed to suppliers
How do you manage credit owed by customers ?
Credit control
Selling off debts to debt factors
Cash discounts for prompt payments
Improved record keeping
What is stocks ?
Cash tied up in raw materials, work in progress and finished goods
Why do businesses use debt factors ?
• The selling of debtors (money owned to the business) to a third party
• This generates cash
• It guarantees the firm a percentage of money owed to it
• But will reduce income and profit margin made on sales
• Cost involved in factoring can be high
What is credit control ?
• Establishing credit limits for new customers
• Credit checking new and existing customers
• Setting realistic credit limits
• Monitoring the age of debts and chasing up bad debts
• Determine appropriate terms and conditions for credit
• Chasing up debtors will get payment in sooner but may upset customers
How do businesses manage cash paid to suppliers ?
• Trade credit - amounts owed to suppliers for goods supplied on credit and not yet paid for
• Delayed payment means that the firm retains cash longer
• Have to be careful not to damage firm’s credit reputation and rating
• Trade creditors are seen (wrongly) as a “free” source of capital
• Some firms habitually delay payment to creditors in order to enhance their cash flow - a short sighted policy and raises ethical issues
How do businesses improve their cash position for the short term ?
• Short term
– Reduce current assets (stock and debtors)
– Increase current liabilities (delaying payment)
– Sell surplus fixed assets
How do businesses improve their cash position for the long-term ?
• Long term
– Increase equity finance
– Increase long term liabilities
– Reduce net outflow on fixed assets
