Liquidity

• A statement of financial position/ balance sheet is a snapshot of what a business is worth at a certain time
• The statement of financial position shows a businesses assets and its liabilities and therefore a balance of the two figures
• The assets a business may own may be equipment, machinery, vehicles, property, buildings whereas liabilities are what the business owes - examples may be long term loans, overdrafts or mortgages
• The document also contains capital; capital is the money put into the business via the owner as well as the sources of finance used to purchase assets - for this reason, the value of assets will equal the value of liabilities & capital; this is because all resources either have to financed through capital or liabilities. Therefore: Assets = Capital + liabilities
• Non-current assets are assets that are long-term resources and are not expected to be sold within the next 12 months; examples may include land, property, equipment, vehicles (Fixed assets) - Intangible assets such as brand names are also non-current assets
• Current assets are short-term resources which can easily be converted into cash within one year; examples may be stock, inventories, cash, and receivables/ debtors (money owed by customers)
• Current liabilities is any money owed by the business that must be repaid within a year; examples may include loan payments, trade and other payables (money owed to suppliers), Tax
• Non-current liabilities are liabilities that don't have to be repaid within a year; examples may include long-term bank loans, mortgages, and pension liabilities
• The current ratio: Current assets / current liabilities
• Following the current test ratio, a ratio of 1.5-2.5 indicates acceptable liquidity and efficient management of working capital; a ratio well below 1 indicates possible liquidity problems however too high of a ratio may suggest too much working capital tied up in inventories + debtors
• The acid test ratio: Current assets - Inventories / Current liabilities; This is a better representation as it excludes inventories which aren't always guaranteed to be sold
• An acid test ratio of above 1 portrays good liquidity and although below 1 shows poor liquidity, for a business which has high stock turnover an acid test ratio of above 0.4 will be good as once high amounts of inventory has been sold, the liquidity will increase; examples may include supermarkets or retail shops e.g. Primark