1. Liquidity 2 lessons covering liquidity. We will look at:
What is meant by liquidity, measuring and calculating:
Current ratio
Acid test
Ways to improve liquidity
Managing working capital
Reinforcement of the importance of cash

2. What is ‘liquidity’?
Refers to the ability of a firm to find the cash to pay its bills
Shows how vulnerable or resilient a company is to short- term shocks
To be ‘liquid’, money needs to be available to be used quickly – either cash in a current account or an asset that can easily be turned into cash to pay bills
This availability of cash is compared to the known, upcoming bills to assess ‘liquidity’
This information is found on the ‘balance sheet’ or ‘statement of financial position’

3. Statement of financial position (Balance Sheet)
 Main categories
£000
Non-current assets eg buildings
1,500
plus
Current assets eg cash
600
minus
Current liabilities eg payables
400
Non-current liabilities eg loans
700
Equals
Net assets, which is the worth of the business
1,000
All PLCs must publish documents showing financial performance including a ‘statement of financial position’, known as a ‘balance sheet’
This records all the assets and liabilities of a business.
Assets = what the firm owns
Liabilities = what the firm owes / must pay or pay back
Net assets = the value of the company
Take Ted Baker and put in this format

4. Current liabilities = bills which must be paid within 12 months
 Main categories
£000
Non-current assets eg buildings
1,500
plus
Current assets eg cash
600
minus
Current liabilities eg payables
400
Non-current liabilities eg loans
700
Equals
Net assets, which is the worth of the business
1,000
 Current assets
£000
Inventories (stocks)
200
Trade and other receivables
250
Cash
150
Total current assets
600
 Current liabilities
£000
Trade and other payables
250
Short-term loans
150
Total current liabilities
400
Current = ‘short term’
- in the next 12 months
Current assets = the finance they have, or expect to have in the next 12 months
Inventories = stock ready to be sold (eg clothes in a clothes store – will be turned into cash when sold)
Trade receivables = money owed to them by customers who have bought goods but have not yet paid for them (bought on credit)
Current liabilities = bills which must be paid within 12 months
Trade payables = bills from suppliers (eg. thi business owes £250,000 to its suppliers. This firm must have received goods from their suppliers but did not pay immediately (trade credit). This bill still must be paid.
Short-term loans = loans which need to be paid back within the next 12 months

5. Measuring liquidity – current ratio
This business will have to pay out £400,000 over the next 12 months
Does it have enough short-term assets (finance) to pay these bills?
Compare current assets to current liabilities in a ratio – the ‘current ratio’
 Current assets
£000
Inventories (stocks)
200
Trade and other receivables
250
Cash
150
Total current assets
600
 Current liabilities
£000
Trade and other payables
250
Short-term loans
150
Total current liabilities
400
Current Ratio = current assets ÷ current liabilities (expressed as a ratio)
In this case 600 : 400, or 1.5 : 1, shortened to ‘1.5’
Accountants believe an ideal ratio is 1.5
Less than this means the firm may not have enough to pay bills and may become bankrupt; higher and the firm may have too many resources not being used
Take Ted Baker and put in this format

6. Measuring liquidity – acid test
 Current liabilities
£000
Trade and other payables
250
Short-term loans
150
Total current liabilities
400
Another ratio looks more carefully at a firm’s ability to pay bills by excluding inventories
inventories may take time to turn into cash
may need to reduce prices to sell stock quickly, reducing their value & contribution to paying bills
This is the ‘acid test’ ratio
 Current assets
£000
Inventories (stocks)
200
Trade and other receivables
250
Cash
150
Total current assets
600
Acid test = (current assets – inventories) ÷ current liabilities (expressed as ratio)
In this case (600 – 200) ÷ 400 = 400:400
Which is 1:1 or shortened to ‘1’
Ideal ratio is 1
Take Ted Baker and put in this format

7. Liquidity ratios Current Ratio Current Assets : Current Liabilities
Statement of financial position £m
Non-current assets
Inventories
Receivables
Cash & cash equivalents
Total current assets
Current liabilities (8160)
Net current liabilities (2315)
Non-current liabilities (6000)
Net assets
Share capital
Reserves & retained earnings
Total equity
Current Ratio
Current Assets : Current Liabilities
Acid Test
Liquid Assets : Current Liabilities
Do you think this business has enough short
term assets to meet its short term debts?
Liquid assets has been calculated as:
Receivables + cash & cash equivalents.
Explain an alternative way of calculating
liquid assets.

8. Liquidity
A business with low liquidity is in danger if short term creditors demand payment quickly e.g. the bank recalls an overdraft
Business may seek to improve liquidity:
Increase current assets and/or reduce current liabilities
Sell assets that aren’t being used i.e. turn them from a non-current assets to a current asset (cash)
Switch to long term sources of finance – money doesn’t have to be repaid so quickly
Monitor debtors & tighten up on credit given to customers
Postpone investment plans
What steps could a business take to improve cash flow?
What is the relationship between cash flow and liquidity?

9. Working capital
Another measure of liquidity / ability to meet day to day expenses
Working capital = current assets – current liabilities
On the statement of financial position as ‘net current liabilities’ or ‘net current assets’
Working capital answers the question: If the firm had to pay off all its short term debts could it do so out of its short term resources i.e. inventories, payables and cash
If not then it may have to sell non-current assets to pay its debts and the business may cease trading e.g. if a limousine hire business has to sell its limousines it no longer has a business

10. Practice question
Using the extract from SuperGroup Plc’s statement of financial position calculate:
Current ratio
Acid test
Working capital
Comment on the liquidity of SuperGroup Plc.