Liquidity and ratios

Question 1

What is liquidity ?

Answer 1

This refers to the ability of a business to pay it’s debts and liabilities in cash when they fall due.

Question 2

What is a current ratio ?

Answer 2

This ratio compares the current assets with current liabilities

Question 3

How is it calculated ?

Answer 3

Current ratio = Current assets / current liabilities

Question 4

How is expressed as a ratio ?

Answer 4

2 : 1 - this shows that there is £2 of profit to every £1 of debt.

Question 5

What is a healthy figure of profit ?

Answer 5

Between £1.5 - £2, if it is above £2 then the business is not efficient eg, could be investing in other areas.

Question 6

What is an acid ratio ?

Answer 6

This shows what cash you have and how much money is tied up in stocks.

Question 7

How is the acid test ratio calculated ?

Answer 7

ATR = Current assets - stocks / current liabilities

Question 8

What is a healthy ATR ?

Answer 8

Between 1 and 1.5 - if below this it doesn’t mean that the business is not liquid as the stocks have been deducted

Question 9

What is working capital ?

Answer 9

This is the money within a business that is needed to pay for the day-to-day running costs.

Question 10

How to calculate working capital ?

Answer 10

Working capital = Current assets - Current liabilities

Question 11

Ways to improve liquidity

Answer 11

• Encourage cash sales
• Negotiate ST loans
• Use an Overdraft facility
• Take out credit agreements with suppliers
• Delay payments
• Sell off current assets (stocks)