Liquidity

• liquidity?


  ability of business to meet its short term commitments with its available assets
• statement of financial position/balance sheet?


  helps identifies a businesses assets and liabilities and specifies the capital (money) to fund business
• liquidity is measured in two ratios:


  • current ratio
  • the acid test ratio/liquid capital ratio
• current ratio:

  • effective liquidity measure for businesses that hold little stock
• current ratio = current assets / current liabilities
• the acid test ratio?

  • important measure of liquidity for businesses that hold a large amount of stock
• acid test ratio = current assets - inventory / current liabilities
• ways to improve liquidity:


  • manage business better
  • use cash flow forecasts
  • budget effectively + consider zero budgeting
  • set clear financial objectives
• working capital?


  money that a business has fund its day to day activities
• working cap = current assets - current liabilities
• liquid?


  an asset that is capable of being used to settle debts immediately
• what happens if there is too much working capital?


  • business will miss out on benefits of investing on assets/investments - opportunity cost since interest rates are high
  • if holding large amounts of inventory, it may incur extra storage costs and use cash 'tied up'