Current Ratio Calculation:

Current Ratio = Current Assets / Current Liabilities

Current Ratio = £45,000 / £25,000 = 1.8

Interpretation: A current ratio of 1.8 indicates that ABC Ltd has £1.80 of current assets for every £1 of current liabilities. This suggests a reasonable ability to meet its short-term obligations. Generally, a current ratio of 2 or above is considered healthy. However, it's important to consider the industry. A ratio significantly higher than the industry average might indicate inefficient use of assets.

Acid Test Ratio Calculation:

Acid Test Ratio = (Current Assets - Stock) / Current Liabilities

Acid Test Ratio = (£45,000 - £5,000) / £25,000 = £40,000 / £25,000 = 1.6

Interpretation: The acid test ratio of 1.6 shows that ABC Ltd has £1.60 of acid test assets for every £1 of current liabilities. This is a more stringent measure of liquidity as it excludes stock, which may not be easily converted to cash. An acid test ratio of 1 or above is generally considered acceptable, indicating a good ability to meet short-term liabilities even if stock is not readily available for sale. A ratio below 1 could signal potential liquidity problems.

Implications for Short-Term Financial Health:

• A current ratio of 1.8 and an acid test ratio of 1.6 suggest that ABC Ltd is in a relatively good position to meet its short-term obligations.
• The company has sufficient liquid assets (excluding stock) to cover its immediate liabilities.
• However, it's crucial to analyze the composition of current assets. High levels of slow-moving inventory could indicate a problem.
• The company should monitor its cash flow closely to ensure it can maintain its liquidity position.

Working capital is the difference between a business's current assets and its current liabilities. It represents the funds available to finance day-to-day operations. It's essential for a business to maintain a sufficient level of working capital to meet its short-term obligations and ensure smooth operations.

Two methods a business can use to improve its working capital are:

• Improving Inventory Management: This involves optimizing inventory levels to reduce the amount of capital tied up in stock. Techniques include Just-in-Time (JIT) inventory systems and better demand forecasting. Drawback: JIT systems are vulnerable to supply chain disruptions and require very accurate forecasting. Stockouts can occur if demand is underestimated.
• Negotiating Extended Credit Terms with Suppliers: This allows the business to delay payments to suppliers, improving its cash flow. Drawback: Suppliers may charge higher prices for extended credit terms, reducing profit margins. It can also damage relationships with suppliers if not managed carefully.

Current Ratio = Current Assets / Current Liabilities

Current Ratio = £40,000 / £25,000 = 1.6

A current ratio of 1.6 means that the business has £1.60 of current assets for every £1 of current liabilities. This suggests that the business has a reasonable ability to meet its short-term obligations. It indicates a healthy level of liquidity.

One potential problem associated with a very high current ratio is that it could indicate that the business is not using its assets efficiently. For example, it might be holding too much cash or inventory that is not being sold quickly. This ties up capital that could be used for more profitable investments.