There are a number of defi nitions of gearing but for our purposes we
will adopt the following formula:
Total liabilities divided by total assets
If the resulting percentage is greater than 65% then your business is
in danger of over-borrowing, which means that it has a very high level
of debt to fund. This may put your business in a weak fi nancial position,
with more of your profi t and cash fl ow having to be allocated to fund
that debt.
Liquidity
Liquidity indicates the amount of liquid assets available to fund short-
term debt such as bank overdrafts and creditors.
Liquid assets are those assets which can be turned into cash relatively
quickly, for example, stock and debtors. The generally accepted safety
benchmark is to have a liquidity ratio of at least 150%.
The formula for liquidity is:
Current assets divided by current liabilities
Look at the example balance sheet (page 58). Current assets are shown
at A and current liabilities are shown at D. The totals of these are used in
the formula for liquidity.
Remember that in your balance sheet you should aim to always
have a minimum ratio of 150%. This means that your current
liabilities are covered 1.5 times by your current assets. You
therefore have more than enough liquid assets to turn into cash
should you need to pay all of your current liabilities in a hurry.
30 Blake’s GO GUIDES
Accounting DiZign.indd 30 15/2/06 9:51:38 AM
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