Liquidity(2.3.2) Flashcards
(15 cards)
What is liquidity?
the ability to pay bills in cash when they fall due
or
the ability to meet current liabilities with current assets
Net assets calculation
net assets = assets - liabilities
Current ratio
quick way to measure liquidity
all forms of current asset are considered in this ratio
effective liquidity measure for businesses that hold little stock
result indicate how many £ of current asset it has available to cover each $1 of short term debt
Current ratio equation
current assets / current liabilities = ?:1
Acid ratio test
precise way to measure liquidity
least liquidity form of current assets is deducted so a more realistic measure of the businesses ability to meet short terms debts quickly is provided
particularly important measure of liquidity for businesses that hold a large amount of stock
Acid ratio test equation
(current assets - inventory) / current liabilities = ?:1
What is working capital?
the money that a business has to fund its day to day activities
often described as net current assets on statement of financial position
Working capital equation
working capital = current assets - current liabilities
Ways to improve liquidity
make use of overdraft or short term loans
find new ways to make revenue and reduce drawings from the business
sell of excess stock
reduce the credit period offered to customers
ask suppliers for an extended repayment period
sell assets and lease fixed assets instead
Make use of overdraft or short term loans - ways to improve liquidity
current liabilities will increase
the business can spend more money than it has in its bank account
banks may be reluctant to lend to businesses with cash flow problem
Find new ways to make revenue and reduce drawings from the business - ways to improve liquidity
new capital may be introduced by the owner or from additional investors
may result in the dilution of control of the business
Sell of excess stock - ways to improve liquidity
less liquid current assets will be reduced and converted into more liquid forms of current assets e.g cash
storage and security costs may also be reduced
stock may need to be sold at a low price to attract sales
Reduce the credit period offered to customers - ways to improve liquidity
collecting money owe from customers more quickly will increase the level of current assets in the business
customers may move to competing businesses that offer better credit terms
Ask suppliers for an extended repayment period - ways to improve liquidity
current liabilities will not be reduced
the business can use cash it would have paid to suppliers for other purposes
suppliers may be unwilling to extend credit terms
Sell assets and lease fixed assets instead - ways to improve liquidity
both current assets and liabilities will increase
the business will continue to have the use of assets but must make regular payments to the leasing company
