34.1 Liquidity ratios

0.0(0)
studied byStudied by 0 people
learnLearn
examPractice Test
spaced repetitionSpaced Repetition
heart puzzleMatch
flashcardsFlashcards
Card Sorting

1/3

encourage image

There's no tags or description

Looks like no tags are added yet.

Study Analytics
Name
Mastery
Learn
Test
Matching
Spaced

No study sessions yet.

4 Terms

1
New cards

Liquidity

The ease of which the business is able to meet its short-term debts or liabilities. It's an important measure of the businesses' ability to continue trading and is often associated with working capital.
- Current ratio
- Acid test ratio

2
New cards

Current ratio

A liquidity ratio that shows the ease at which the company is able to pay its short-term obligations using current assets expressed as a ratio. A low ratio might suggest a need to increase current assets while a ratio of over 2:1 suggest that too much funds are tied up in unprofitable inventories, cash and trade receivables.

Formula: current assets / current liabilities

3
New cards

Acid test/Quick ratio

A liquidity ratio that shows the ease at which the company is able to pay its short-term obligations using liquid assets, which means ignoring inventories, expressed as a ratio. A low ratio might suggest a need for caution, but previous figures should also be considered to gain a clearer picture of company performance. Selling inventories for cash will NOT improve the current ratio (since both cash and inventories are included) but it will improve the acid test ratio since cash is a liquid asset.

Formula: liquid assets / current liabilities

Liquid assets: current assets - inventories

4
New cards

Method to increase liquidity + evaluation

1. Selling fixed assets for cash (land and property to a leasing company)

- The asset might not be sold for its true value

- If the asset is needed again leasing will be required which will increase overheads and decrease the operating profit margin

2. Selling inventories for cash at discount

- Brand image might be damaged if the inventories are sold at low prices

- Selling inventories at a discount will decrease gross profit margin

3. JIT inventory management (cutting inventories through this approach)

- Inventories might be needed to accommodate changing customer demands

4. Increase loans

- Gearing (the proportion of business activities funded by liabilities) will increase

- Rising interests will decrease profit figures