Future Business Leaders of America (FBLA) Accounting Practice Test

Which financial statement is primarily used to assess the liquidity of a business?

1. Income Statement

2. Cash Flow Statement

3. Balance Sheet

4. Trial Balance

The correct answer is: Balance Sheet

The Balance Sheet is the primary financial statement utilized to assess the liquidity of a business because it provides a snapshot of a company's assets, liabilities, and equity at a specific point in time. Liquidity refers to the ability of a business to meet its short-term obligations, and the Balance Sheet displays the current assets that are available to cover the current liabilities. Current assets typically include cash, accounts receivable, and inventory, while current liabilities include accounts payable and other short-term debts. By analyzing the relationship between current assets and current liabilities, stakeholders can determine the company's liquidity position and its capacity to handle immediate financial responsibilities. In contrast, the Income Statement primarily reflects the revenues and expenses over a specific period, providing insights into profitability but not directly measuring liquidity. The Cash Flow Statement offers a detailed analysis of cash inflows and outflows over a period, which is important for understanding cash management but focuses on cash rather than overall asset and liability positions. Lastly, the Trial Balance is an internal document used to ensure that total debits equal total credits and does not serve as a formal financial statement or a tool for assessing liquidity.