2.3.2 Liquidity

• The Statement of Financial Position shows the financial structure of a business at a specific point in time

  • It identifies a businesses assets and liabilities and specifies the capital (money) used to fund the business
  • The Statement of Financial Position is also known as the Balance Sheet
• • The liquidity of a business can be measured using two ratios, the current ratio and the acid test ratio 
• The Current Ratio

  • The Current Ratio is a quick way to measure liquidity and the outcome is expressed as a ratio

  Calculation

  CR = current assets / current liabilities
• The Acid Test Ratio

  • Is a precise way to measure liquidity and is expressed as a ratio

  ATR = current assets - inventory / current liabilities
• The best way to improve liquidity is to manage the business better

  • Use cash flow forecasts to identify potential cash flow issues before they arise - and take appropriate action
  • Budget effectively and consider adopting zero budgeting to carefully control spending
  • Set clear financial objectives and look for ways to reduce costs and increase income wherever possible
• • Working capital is the money that a business has to fund its day to day activities

  Working capital = current assets - current liabilities
• Managing Working Capital

  • Working capital is described as the lifeblood of a business because a lack of working capital often leads to business failure as a business cannot meet its immediate financial obligations
• Net assets = assets - liabilities
• Non-current assets - items that are owned by a business for the long term e.g buildings and machinery
• Current assets - items that are kept for short term and are typically converted into cash after one year e.g inventory
• current liabilities - Money a business owes and is due to be settled soon (Within 12 months)
• Non-current liabilities - Money a business owes and that does not need to be paid back for at least 12 months