Summary
Summary Liquidity
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Explains what a statement of financial position (balance sheet) is, assets and liabilities, liquidity ratios (acid test and current ratios), and working capital
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Theme 2 Topic 13Liquidity
Statement of Financial Position (Balance Sheet)
Statement of Financial Position – describes the finances of a company at a particular point in time, by
comparing the items owned by the business with the amount it owes
It does not show the businesses performance over a period of time but is a
snapshot of what the business owns (assets) and owes (liabilities) on one
particular day
Assets
Assets – items that are owned by a business, e.g. cash in the bank, vehicles
and property
Assets are divided into 2 categories:
1) Non-Current Assets – items that can be used repeatedly in the
production process that tend to last for more than one year e.g.
buildings, machinery, vehicles
2) Current Assets – items that are used up in the production process
and last less than one year e.g. inventories, receivables or cash
Liabilities
Liabilities – debts owed by the business e.g. to suppliers, investors or lenders
Liabilities are also divided into 2 categories:
1) Non-Current Liabilities – debts due for repayment after more than one year e.g. loans
2) Current Liabilities – debts to be paid back within one year e.g. overdrafts, corporation tax, dividends
due for payment or payables
Liquidity Ratios
Liquidity – the ability to convert an asset into cash without loss or delay
The order in which assets are most liquid is as follows:
1st – Cash (and electronic money/cards)
2nd – Receivables (money owed to the business)
3rd – Stock (inventory)
There are two liquidity ratios – the current ratio and the acid test ratio. They identify if a business has enough
cash, receivables and stock (current assets) to pay for the short-term debts (current liabilities). If a business
has poor liquidity it will have poor cash flow problems.
Solvency – a measure of a firms ability to pay its debts on time. A firm that can meet its financial commitments
is ‘solvent’, and a firm which can’t meet its financial commitments is ‘insolvent’
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