Equity and Liquidity
Net Ccrrent assets describe working capital, which in turn describes liquidity, which illustrates how strongly placed a business is to meet its liabilities going forward.
Net current assets, are calculated as follows:
| Cash in the Bank and in Hand |
| plus: Cash Convertibles (within 1 year) e.g. Current Assets: Stock; Debtors; Prepayments |
| less: Current Liabilities (payable within 1 Year) e.g. Creditors; Asset Finance; the Overdraft |
| equals: Net current Assets / Working Capital |
Note that fixed assets of any description play no role when calculating net current assets; they omnly ever represent "illiquid" assets.
Working Capital and Cash Flow
Liquidity measures the ability of a business to pay its bills on time.
Its job is to generate sufficient cash within normal business activities as and when it's needed to pay the bills on time. If your Figurewizard balance sheet forecast is showing a deficit for working capital you will be predicting that will not happen.
As that is definitely not recommended it will be time to turn to the What-If Calculator to revise your projected figures..
Depleting Working Capital
Trading losses are not the only route to negative working capital deficit. Spending cash and creating new debt are inevitable bedfellows when investing in fixed assets. If that turns out to have been excessive though, negative working capital will be the result regardless of profits.
Forecasting Working Capital
Avoiding such problems calls for planning and that in turn relies on accurate and comprehensive forecasting.
This is what Figurewizard enables you to do, usually in less than ten minutes, and that includes calculating and applying all possible VAT and corporation tax liabilities without any intervention on your part.
I still cant get my head round a business having 750,000 in the bank having a problem. Surely if I sell goods to them on credit they must be able to pay with that sort of money in the bank?
Forget the £750,000 in cash and concentrate on the £1,713 of working capital and the "current liabilities". In the example above those liabilities amount to £1,016,256 so that if they were to use all of their cash to pay creditors, they would still be left with a balance of current liabilities totalling £266,256 that also must be paid. To pay those will need collecting every penny from "sundry debtors" in short order (e.g. less than thirty days) with no delays; no disputes and no bad debts.
If they were able to do this; which in the real world is highly unlikely, selling goods on credit to them with a working capital ratio of 0.17% to liabilities can only mean that your position in their pecking order would be worth £1,713 at its very unlikely best. Even then that £1,713 would depend on them not having spent any more cash or having incurred any more debts in the meantime.
I have run forecasts and my balance sheet is showing net current assets of £20575. Is this my true liquidity or is it the short term liquidity and if so what is the difference?
@GGCook Because current assets are those which are considered to be genuinely cash convertible within twelve months, net current assets (AKA working capital) is the generally accepted definition of liquidity. Short term liquidity, which is assessed without stock / inventory means what it says however and should be referred to in order to establish how much external financing or loans are required to meet temporary shortfalls in budgeted cash flow.
What is the situation with fixed assets that are financed by hire purchase? Would the cash due for repayments be treated as current liabilities too or would they be exempt? I ask this because I am being told by my accountant that with rules coming into force in 2019 it might be better to buy assets outright, financed by hire purchase rather than to lease them.
Current liabilities represent all liabilities payable within twelve months. The fact that that the debt is attached to a fixed asset does not alter the fact that it is cash that is expected to be taken out of the business.
Your point regarding changes from 2019 regarding leases is an important one. This arises from a new accounting protocol; IFRS 16 that will affect all balance sheets and perceived liquidity. Click here for more on this.