Liquidity

• Statement of financial position shows a business’s assets and liabilities at a specific point in time
• Current assets are assets that can be converted into cash within a year
• Current liabilities are debts that are generally settled within a year
• Liquidity is the ability of a business to pay its short-term debts
• Current ratio is calculated by dividing total current assets by total current liabilities
• Ideal current ratio is between 1.5 to 2 to 1
• Acid test ratio is calculated by subtracting stock from current assets and dividing by current liabilities
• Ideal acid test ratio is around 1 to 1
• Ways to improve liquidity include selling fixed assets, postponing investments, and seeking sources of finance
• Increasing long-term liabilities can provide more cash to pay short-term liabilities
• Managing working capital through stock control, reducing lead times, collecting receivables promptly, and delaying supplier payments

The video discusses a business’s statement of financial position, also known as a balance sheet, and how it can be used to assess liquidity. The balance sheet shows the assets and liabilities of a business at a specific point in time, while the income statement shows the profit or loss over a period of time. The assets are divided into fixed assets (owned for more than a year) and current assets (used up or converted into cash within a year). Liabilities are categorized as current liabilities (settled within a year) and non-current liabilities (due over a longer period). Liquidity refers to a business’s ability to pay short-term debts, and it is determined by the ratio of current assets to current liabilities. The current ratio is calculated by dividing total current assets by total current liabilities, while the acid test ratio subtracts stock from current assets before dividing by current liabilities. A current ratio of more than 1 indicates a better liquidity position, with a range of 1.5 to 2 being considered safe. The acid test ratio can be slightly lower, but a ratio of around 1 is still desirable. If a business faces liquidity problems, it may consider selling fixed assets, postponing investments, or seeking sources of finance such as share capital and loans.

Businesses can manage their working capital and improve their liquidity by considering various strategies. One approach is to carefully manage their stock control, ensuring that they do not have excessive amounts tied up in inventory. By reducing lead times, businesses can also receive payments more quickly. Additionally, businesses can focus on promptly collecting payments from customers while delaying payments to suppliers. This helps to improve the working capital and overall liquidity. Lastly, reducing spending on fixed assets allows businesses to allocate more funds towards day-to-day operations and meeting short-term financial obligations. By implementing these strategies, businesses can enhance their financial stability and ensure they have sufficient cash flow for their daily operations.