Business 2.3.2 - Balance sheets and Liquidity

Every year limited companies have to send a statement of the financial position known as balance sheets to the companies house. A balance sheet shows what the business owns, what it owes and where it got the money from.

The key question is: Does the firm have enough cash to pay its bills? (Which is answered in terms of liquidity)

Liquidity is the ability of a business to find the cash it needs to pay bills. The cash must be readily available either in the bank account or in the form of a payment from a customer that is due very soon.

A balance sheet shows more info than needed to measure the liquidity and when looking at a whole balance sheet the section needed to measure liquidity is the current assets and the current liabilities. Measuring liquidity involves comparing the value of current assets against the current liabilities that will need to be paid. Either calculating the current ratio or calculating the acid test ratio is used to measure liquidity.

• Current ratio = Current assets / Current liabilites
• Acid test ratio = (Total current assets - inventories) / current liabilites

Current ratio:

• The current ratio calculation enables a simple judgement to be made about a firms…