Ch 29: Business Finance

Question 1

What is liquidity?

Answer 1

Liquidity is the ability of a business to convert its assets into cash to pay off its liabilities

Question 2

What is an asset? and define the two types of assets

Answer 2

An asset is any resource that a business owns which has a monetary value.

Current assets: assets business expects to use or sell within a year

Non-current assets: assets business cannot convert into cash within a year or use for more than an year

Question 3

What is a liability?

Answer 3

Liability is any kind of financial obligation that a business has to pay at the end of an accounting period.

Question 4

Explain the two types of liabilities

Answer 4

1) Current liability: short-term financial obligations which are due within one year (trade creditors, overdraft)

2) Non-current liability: long-term financial obligations that isn’t due to pay for more than an year.

Question 5

What does lack of finance result in?

Answer 5

1- Administration
2- Bankruptcy
3- Liquidation

Question 6

What is administration?

Answer 6

Administration is a process in which specialist accountants are hired to keep the business operational and to find a buyer for it. This occures due to lack of finance.

Question 7

What happens if administration fails?

Answer 7

If through administration business can’t remain operational then bankruptcy will result.

Question 8

What happens in bankruptcy?

Answer 8

In bankruptcy a legal process begins which leads to liquidation of the assets of the business.

Question 9

What is liquidation?

Answer 9

Liquidation is used to raise as much finance as possible. Trade is stopped and assets are sold. This is done to pay back people and companies the bankrupt business owes money to.

Question 10

What is working capital?
Give its formula

Answer 10

To finance day to day expenses is known as working capital.

Working Capital= Current Assets -
Current liabilities

Question 11

Disadvantages of low working capital

Answer 11

Low working capital:
- inability to pay supplier on time ruins reputation and more credit offers are discouraged.
- if workers dont get paid on time they get demotivated
-if business can’t pay for utilities consumed this can result in tier discontinuation
- business operations might have to stop

Question 12

Disadvantages of high working capital than required.

Answer 12

• idle resources in the form of current assets
• opportunity cost of not earning profit
• cash can lose value over time (inflation)
• operational inefficiency

Question 13

What is a working capital cycle?

Answer 13

Working capital cycle is the time is takes to convert invested cash or net current assets back into cash.

Shorter the cycle the better as cash will free up faster, if the cycle is long business will require high working capital to operate.

Cash-> Inventory-> Finished goods -> Account receivables-> cash