2.3.2 Liquidity

• Current Ratio


  Current assets/ current liabilities
• Interpretation of Current Ratio

  The ideal current ratio is 1.5:1 higher means the firm has too many unproductive assets, and lower means they may not be able pay debts
• Acid Test Ratio

  Current assets - inventory/ current liabilities
• Interpretation of Acid Test Ratio


  The ideal is 1:1 higher means strong liquidity and lower may mean difficulties with payments
• Ways to Improve Liquidity

  -Selling under-used fixed assets

  -Raise share/ loan capital

  -Postpone investments

  -Improve management of working capital
• Working Capital

  The finance available for paying short-term debts so the business can operate and is = Current assets - current liabilities
• Ways to Manage Working Capital

  -Minimising stock levels

  -Keeping customer credit low

  -Getting credit from suppliers

  -Getting goods to the market fast

  -Spend less on fixed assets
• Problems with Poor Cash Flow

  -Business failure if bills are not paid

  -Higher variable costs if materials aren't bought in bulk

  -May lose lucrative opportunities eg. large orders

  -No funds for development
• Contingency Finance


  Keeping cash in the firm's current account or not using overdraft to prepare for unexpected events