The accounting equation

Question 1

What is a balance sheet?

Answer 1

Reports financial position at a point in time.
Follows the Accounting Equation.

Question 2

Whats the difference between current and non current assets?

Answer 2

Classifies items as Current (≤12 months)
Non-current (>12 months)

Question 3

What is liquidity?

Answer 3

Liquidity refers to the ability of a business to meet its short-term
debts as they fall due and can be measured using the Working
Capital Ratio, which should be above 1:1.

Question 4

How is liquidity measured?

Answer 4

Working Capital Ratio = Current Assets / Current Liabilities
E.g. $16,000 / $10,000 = 1.6:1
Means the business has $1.60 for every $1 owed short-term.
Healthy liquidity if ratio > 1

Question 5

What is stability?

Answer 5

Stability refers to the ability of a business to meet its long-term
obligations and remain a Going concern.

Question 6

How is stability measured?

Answer 6

The Debt Ratio measures the percentage of the firm’s assets that are funded by external (outside) sources, and it is a good indicator of financial risk. Measured by:
Debt Ratio = (Total Liabilities / Total Assets) × 100
E.g. $19,000 / $34,000 = 56%
Shows that the business is reliant of 56% of external funding
High ratio = higher financial risk

Question 7

What are assets?

Answer 7

A present economic resource controlled by the entity as a result of past events, with the potential to produce economic benefits. e.g.
physical: Vehicles, Financial: Cash (incl. electronically received)

Question 8

What are liabilities?

Answer 8

A present obligation of the entity arising from past events, which will result in the transfer of economic resources. e.g. accounts payable/GST payable

Question 9

Define owners equity

Answer 9

Residual interest in the assets after deducting liabilities.
Increased by: Profit, Capital
Decreased by: Drawings

Question 10

What is the formula of the accounting equation?

Answer 10

Assets = Liabilities + Owner’s Equity
Must always balance