1.Liquidity.ppt

MODULE 4 RATIO ANALYSIS A2 Marketing and Accounting and Finance Liquidity The amount of cash available in a business to meet daily requirements / meet debts as they fall due. Definition, Calculation and Interpretation Definition and Calculation Acid test ratio - assesses liquidity. Definition, Calculation and Interpretation Definition and Calculation Current assets less stock = X : 1 Current liabilities Example: Current assets less stock = ￡148,000 Current liabilities = ￡80,000, Acid test ratio = 1.85:1 Definition, Calculation and Interpretation Definition and Calculation Stock left out because: it is the least liquid asset. it can take a long time to convert into cash. it may become obsolete, and thus unsaleable. Definition, Calculation and Interpretation Definition and Calculation Accountants suggest 1:1 is ideal. This means that… for every ￡1 of short-term assets, ￡1 of short-term debt. Below 1:1 - danger insufficient cash to meet debts. Definition, Calculation and Interpretation Interpretation ‘Current’ = receivable / payable within next 12 months. Must not assume below 1:1 = insolvency. Certain bills eg tax, dividends - not paid for 6 months. Some businesses may use fixed assets to generate cash. Low Liquidity – Implication of Risk (avoiding Determinism) delaying payments to suppliers, resulting in poor reputation, refusal of future credit. loss in purchasing economies of scale. Low Liquidity – Implication of Risk (avoiding Determinism) Short-term Implications loss of potential business. increased borrowing - increased costs. refusal by banks / lenders to lend money or higher interests rates. Low Liquidity – Implication of Risk (avoiding Determinism) Short-term Implications Inability to expand / grow. Closure. Low Liquidity – Implication of Risk (avoiding Determinism) Long-term Implications Sell off fixed assets no longer vital. Advantages: · Avoids interest charges and dilution of control. However: