Answer Sheet 16

BALANCE SHEET QUESTIONS

You will find these questions easier if you have completed the Pepper Balance Sheet exercise.
Explain, with an example, the meaning of the following terms:
1. Asset – use the term owned by the firm in your answer

An asset is something that is owned by a business. It can include money, offices and stock.

2. Liability – use the word owed in your answer

A liability is a debt that a business owes to someone else, such as money owed to the bank.

3. Creditor – use the term owe money to in your answer

If Pepper has taken stock from company x, but not yet paid for it, then company x are creditors.

4. Debtor – use the term owed money by in your answer

Debtors owe money to a firm. A customer who has taken goods but has not yet paid for them.

5. Current Assets – use the term cash in your answer

These are assets owned by the business, which are cash, or will become cash in the short term.

6. List two things other than cash that can be included as current assets
Stock and debtors are both current assets. These will become cash in the short term.

7. Current Liability – use the word debt in your answer

A current liability is a debt that the business must pay in the short term, such as creditors.

8. Working Capital
Current assets – current liabilities. The money that the firm has to run the business.

9. Current Ratio

Current assets divided by current liabilities. Shows how easily firms can pay short-term debts.

10. Acid Test Ratio

Current assets minus stock divided by current liabilities. A better measure than current ratio.

11.On Pepper’s balance sheets, which months have an acid test ratio that is dangerously low? Explain
your answer using some numbers. (An acid test ratio should usually be at least 1:1)
In December ’89, the acid test ratio was 0.04. The firm was in a very risky position then.

12.Why is the acid test ratio a more accurate measure of the health of a firm than the current ratio? Use
the word stock in your answer.
The current ratio shows how easily a business can use its current assets to pay its current
liabilities. It includes stock as a current asset. This is sometimes a problem, because a firm’s
stock is often very illiquid (this means it cannot be sold easily). The acid test ratio recognises
this problem by taking stock out of current assets before dividing the result by current liabilities.
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