Liquidity

Question 1

The Working Capital Ratio

Answer 1

Assesses liquidity by comparing current assets and current liabilities

Current Liabilities

Should be at least 1:1
Eg. 1.67:1 = for every dollar that you owe, you are covered by $1.67 in current assets

The working capital ratio must not be too high as this may indicate that the business has got assets such as stock or cash that are idle (not generating a return)

Question 2

The Quick Asset Ratio

Answer 2

Compares quick (immediate) assets with quick liabilities
Current Assets - (stock + prepayments)
—-———————————————
Current liabilities - bank overdraft

1:1

If the quick asset ratio is too low it means that we don’t have enough immediate assets to cover immediate debts and is usually an indication that most of my short term assets are tied up in stock.
We don’t want this because of added storage costs, risk of damage etc

Question 3

The Cash Flow Cover

Answer 3

Measures the number of times net cash flow from operating activities is able to cover average current liabilities.
Net cash flow from operations
———————————–
Average current liabilities

eg. Able to cover 2.8 times the value of your debts

Question 4

Stock Turnover

Answer 4

-This measures the average number of days it takes for a business to convert its stock into sales.

Average stock
——————- X 365
Cost of goods sold

In order for this to improve, COGS has to increase (sales, so selling quicker) or decrease average stock (remover slow moving lines of stock)

Question 5

Stock management strategies

Answer 5

• determining an appropriate level of stock on hand in order to improv the stock turnover
• maintaining an appropriate stock mix
• rotating stock
• ensuring stock is up-to-date
• promoting the sale of complementary goods
• strong marketing which includes offering discounts/incentives to customers to move the stock out quicker

Question 6

The Creditors Turnover

Answer 6

• measures the average number of days it takes a business to pay its creditors.
• the only time we may pay earlier than out credit terms would be if we wanted to take advantage of settlement discounts, however, a business would not want to pay later than the credit terms as this may lead to creditors stopping the supply of goods to us or receiving a poor credit rating which would negatively influence our ability to purchase from other suppliers on credit.

Average creditors
———————- X 365
Credit purchases

Question 7

The Debtors Turnover

Answer 7

Measures the Average number of days it takes for a business to collect its cash from its debtors.

Average Debtors
——————- X 365
Credit sales

The quicker we get our money the quicker we can repay our debts.
Compare to credit terms to determine success

Question 8

Debtor management strategies

Answer 8

• the use of discounts for quick settlement
• prompt invoicing
• extensive credit checks
• reminder notices
• threats of legal action
• threats of not providing credit in the future

Question 9

Liquidity

Answer 9

Refers to the ability of a business to meet its short-term debts as they fall due.

• Any assessment of liquidity should begin by analysing the level of liquid funds available
• It should also analyse the speed at which those liquid resources become available

Liquid funds = non current assets