2.3.2 - Liquidity

• define liquidity:

  • The ability of a business to turn its assets into cash to pay its current liabilities.
• Define statement of financial position (balance sheet):

  • A Plc or Ltd business have publish their accounts by UK law.
• Current ratio formula:

  • current assets/current liabilities
• current ratio:

  • ideal ratio is 1.5:1, lower than this and there is not enough money to pay bills.
  • higher than this and there is too much money tied up.
• Acid test ratio formula:

  • current assets - inventory/current liabilities
  • if acid test ratio is less than 1:1 then its current assets (stock) don’t cover current liabilities.
• Ways that liquidity can be improved:

  • can reduce amount of stock that it holds, so finished goods need to be dispatched faster to customers.
  • can reduce credit period offered to customers, insist customers pay 30 days instead of 90.
  • could pay suppliers later on agreed credit terms.
  • increase borrowing long term and short term debts for less current assets.
• Define working capital:

  • means that the day-to-day finance needed in a business, can be calculated by CA-CL.
• Working capital cycle to improve liquidity:

  • the longer this cycle takes, the longer the cash is tied up in stock or owed by debtors.
• Working capital cycle:

  
• Current ratio formula:

  • current assets/current liabilities