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Liquidity - Coggle Diagram
Liquidity
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Acid Test Ratio
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The ideal value for acid test ratio is 1:1. this would mean that the firm has £1 of current assets ( cash ) for every £1 its current liabilities (debt).
The acid test ratio, does not count stock ( inventories) to be a liquid asset that can be set against a current liability.
If the acid test falls BELOW the ideal, that could cause trouble for a business trying to pay its bills.
However, some firms can trade on surprisingly low acid test ratios. Its less of a problem for a business that can generate millions of pounds per day or one that is large enough to access bank finance fairly easily.
Balance Sheets
Every year, companies are required to send a statement of financial position, commonly known as a balance sheet. This will show what the business owns as well as what it owes and where it got its money from.
CURRENT ASSETS = items a business owns in the form of cash or what can easily be turned into cash: receivables/debtors, stock and cash.
CURRENT LIABILITIES = debts owed by a business that are due to be paid within the next 12 months: trade credit, overdraft.
Managing Working Capital
The Working Capital Cycle ;
capital injected into the business > buy materials > produce goods > sell to customers on credit > customers pay up
Managing this cycle, ensures that there is always enough working capital in the system to prevent blockages or delays, its crucial to successful financial management.
Actively managing requires, ensuring there is enough money in the system, making sure cash moves through the cycle quickly and control cash used by reducing stock levels and controlling credit periods.
Measuring Liquidity
Looking at a balance sheet, the sections to be concerned with are the current assets and current liabilities. Measuring liquidity involves comparing the value of a current asset against the current liabilities that will need to be paid.
The key question answered by a statement of financial position is 'Does the firm have enough cash to pay its bills?'
Improving Liquidity
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This could involve;
selling under-used fixed assets
raising more share capital
increasing long-term borrowing (loans)
postponing planned investments.
Liquidity is the ability of a business to find the cash it needs to pay its bills, the cash must be ready and available in either the bank account or in the form of a payment from a customer that is due very soon.