The concept of liquidity is often found in professional literature, but novice investors rarely pay attention to it. And in vain. After all, the amount of risk and profitability depend on the liquidity of assets. And the quality of the investment portfolio determines investment tactics and strategy, not to mention financial stability. Let's take a closer look at this important economic category.
Economic essence
What is liquidity in simple words? Liquidity is the ability to quickly turn into money without large financial losses. The term liquidity comes from the Latin liquidus - liquid, current, that is, easily converted into money.
The above definition sets the main parameters:
- transformation time;
- the amount of financial costs associated with the transformation.
How is liquidity measured?
The number of days required to sell an asset at an average market price:
- So, you can sell or redeem a high-yield security within a few minutes;
- and the financial liquidity of investments in construction cottage village measured in years.
The most indicative in this sense is the structure of the assets of any manufacturing or trading enterprise. Liquidity:
- Absolute. Assets do not require transformation and represent ready-made products payment ( cash and their equivalents).
- Urgent (up to 7 days). Short-term investments (for example, in government bonds and bills).
- High (up to 30 days). Goods shipped, short-term accounts receivable.
- Medium (up to 90 days). Work in progress, inventories in warehouses (raw materials, materials and finished products).
- Low (up to 360 days). Long-term investments, accounts receivable.
- Illiquid assets. Fixed assets (machinery, equipment, buildings, structures) and intangible assets.
Keep in mind that the above classification is quite arbitrary, since in each group it is possible to identify specific assets that have varying degrees of turnover depending on the specifics of the activity. So, the lifespan accounts receivable may be different. “Long” debt becomes low-liquidity or even illiquid.
With the urgent transformation of any instruments into cash, financial losses are inevitable, which include:
- discount to the market price of an asset provided by the buyer for the purpose of prompt sale;
- additional selling costs (taxes, fees, duties, commissions, etc.).
The following classification of financial losses has been adopted: low (up to 5%); average (up to 10%); high (up to 20%); very high (over 20%).
Obviously, financial losses and the speed of transformation are inversely related.
Why is she so important?
Liquidity is the second most important (after profitability) characteristic of any asset, including investment.
For an investor, especially one operating in the financial market, assessing the quality of an investment portfolio becomes more important than for a large manufacturing or trading enterprise. Causes:
- An individual investor is one by definition. Opportunity to attract alternative sources capital (and thus reduce risks) is limited.
- The average investor, as a rule, does not have a large “safety cushion” behind him in the form of fixed assets: buildings, structures, machinery and equipment.
- In pursuit of profitability, he tends to invest in riskier assets.
Thus, for a portfolio investor, high liquidity means:
- flexibility of investment strategy and tactics (the ability to quickly withdraw funds from ineffective projects and reinvest them);
- speed of turnover, and therefore profitability (the faster you earn money on an investment instrument, the higher the interest rate of effective profitability);
- personal financial stability.
Rule 1. All things being equal, invest in assets with a high degree of liquidity. This will give you freedom of maneuver in the process of managing your investment portfolio.
Rule 2. Profitability and liquidity are interconnected. Investments in low-liquid assets should generate greater investment income.
How to assess the liquidity of an asset
The liquidity of an asset represents the market capacity in which it can be sold or bought.
Market liquidity is determined by:
- Number of transactions.
- The spread (difference) between the maximum stated purchase price (demand) and the minimum stated sale price (offer).
Rule 3. The larger the volume of transactions and the narrower the spread, the more liquid the market.
Thus, individual transactions will not have a significant impact on the market as a whole. This means that if you have an asset with average market parameters, you can sell it at any time.
By analogy with the general rules:
- instant liquidity of the security stock market determined by the number of quotation orders (the author indicates the price and volume, giving other players the opportunity to buy or sell a financial instrument at any time);
- the trading liquidity of a security is determined by the number of market orders (the author indicates only the volume, the transaction is concluded automatically at the best quotation price).
You can always find such information on stock exchange portals, financial and brokerage sites.
Increased price volatility and decreased trading volume indicate investor anxiety and are the first symptoms of increased investment risks. If the situation continues for more than the first week, the liquidity of securities, and with it the profitability, will inevitably begin to fall.
Obviously, it is possible to assess the liquidity of assets in this way only on the exchange market, where securities are traded in an open financial market and free competition.
The rules for trading in the over-the-counter market are established by the counterparties themselves, and the process of concluding a transaction becomes several times more complicated (searching for clients, attracting intermediaries and guarantors, confirmation operations legal status transactions, etc.). As a result, the degree of liquidity of assets in the over-the-counter market is an order of magnitude lower. Moreover, it is difficult to accurately predict and calculate it.
- Research the market segment one-room apartments: number of transactions per period, average price square meter, average price of an object, price range. You can easily obtain such information from real estate market reviews, analytical studies, and agency websites. From the analysis you will learn that the market for economy class apartments in Moscow is considered a well-liquid segment of the real estate market.
- Determine the required level of profitability from the sale.
- Predict the time required to find a buyer.
- Calculate the time required for the entire range of legal and administrative procedures related to the sale (about 1 month).
- Assess the associated financial and tax costs.
Thus, the sales operational cycle alone (searching for a buyer, completing a transaction and receiving funds) will take you 2–3 months. And if you are counting on excess income, the process may take up to six months. That is, a “good” asset by the standards of the real estate market is quickly turning into a low-liquid asset.
What is project liquidity
For the purposes of this article, we will define it as the period of time that has passed from the moment of the first investment until the potential sale of the asset at a price that compensates for the investment, taking into account the time factor (discounting). If you invest money in a venture project today, this investment asset will not become liquid until you are able to exit it with a profit. The event is probabilistic in nature, and, therefore, early stages such investments are completely illiquid.
How to assess the liquidity of an investment portfolio
How to value a specific asset is relatively clear. What if we're talking about about a comprehensive assessment of the quality of the portfolio of an individual investor or an investment company? In commercial enterprises, special coefficients are used for this:
- Absolute liquidity = (Cash and cash equivalents + Short-term investments) / Current liabilities. Standard: 0.2.
- Quick (quick) liquidity = (Current assets - Inventories) / Current liabilities. Standard: 1.
- Current liquidity = Current assets / Current liabilities. Standard: 2.
What is enterprise liquidity? The higher the ratios, the faster the company will be able to turn part of its assets into cash to avoid problems. Moreover, the value of the last coefficient already borders on the assessment of the state of financial stability.
What should a simple investor do? Go the same route.
- Assess the level of liquidity of each specific asset included in your investment portfolio.
- Group your assets.
- Calculate the share of each group in the total portfolio.
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What are liquidity ratios? Description and definition of the concept
Liquidity indicators- This financial ratios, which are calculated based on the systematic reports of the enterprise (the company’s balance sheet) in order to determine the company’s ability to pay off current debts using current or current assets that are available.
Liquidity (Latin liquidus flowing, liquid) is an economic term that refers to the ability of assets to be quickly sold at a price that is set according to indicators as close as possible to the market price. In other words, liquid – convertible into money.
Values (or assets) are usually divided into illiquid, low- and highly liquid. The liquidity of an asset is determined based on how easily and quickly it can be exchanged given its full value. The liquidity of the product will be calculated in accordance with the speed of its sale at the nominal market price, excluding discounts and special offers.
For example, different assets of the same enterprise, which are reflected in the balance sheets, have different levels liquidity (in descending order):
- Money in accounts and cash in the cash registers of the enterprise.
- Types of government securities and bank bills.
- Current receivables, issued loans, securities related to corporate property (shares of an enterprise that are quoted on stock exchanges, promissory notes).
- Stock of goods and types of raw materials in warehouses.
- Equipment and technology.
- Structures and buildings.
- Unfinished construction.
The term liquidity, among other things, can be applied to banks, firms or enterprises, various types of securities, the market, etc.
Liquidity of the enterprise
The list of tasks for analyzing indicators on the financial condition of an enterprise includes assessing its solvency and liquidity.
Tools called liquidity ratios help in assessing liquidity. Liquidity ratios are financial indicators that are calculated on the basis of reports regularly submitted by the enterprise. This occurs in order to determine whether the company is capable of repaying current debt through those current assets which she possesses.
We combine a practical calculation of liquidity indicators with a modification of the company’s balance sheet, which aims to adequately assess the liquidity of assets different types. For example, part of the remaining goods may have zero liquidity; accounts receivable balance – have a few due dates more than a year; bills and loans issued by the company, although formally refer to assets in circulation, in fact they are funds that are transferred for use for a long period of time in order to finance related structures. These components of the balance sheet are taken far beyond the list of assets in circulation and are not taken into account when calculating the liquidity indicator.
Asset liquidity can be divided into 4 practical groups:
- A1 – the most liquid assets;
- A2 – goods sold fairly quickly;
- A3 – assets, the sale of which is rather slow;
- A4 – assets that are difficult to sell.
Asset allocation is done to determine the level of liquidity of the enterprise or balance sheet. Based on this, sources of finance are divided into 4 groups:
- P1 – the most urgent obligations to fulfill;
- P2 – short-term passive;
- P3 – long-term passive;
- P4 – permanent liabilities.
The enterprise is liquid, provided that A1>=P1, A2>=P2, A3>=P3, A4>=P4.
Based on the above groups, specialists calculate liquidity indicators.
Current liquidity
The current liquidity ratio (coverage ratio - from the English Current ratio, CR) is a financial indicator that is equal to the ratio of the total volume of current (current) assets in relation to short-term liabilities (current liabilities). The data is provided by the balance sheet of a company or enterprise. It is calculated using the following formula:
Ktl=(OA-ZU)/KO or K=(A1+A2+A3)/(P1+P2), where
Ktl is the current liquidity ratio;
OA are assets in circulation;
ZU – debt of the founder for contributions to the contents of the authorized capital;
KO - list of short-term liabilities.
This ratio shows the company's ability to pay off its current (short-term) obligation, taking into account only current assets. The higher the indicator, the more solvent the enterprise is. Considering the level of liquidity of assets, it is logical to conclude that not all of them can be sold urgently. A normal indicator is considered to be one that is in the range of 1.5-2.5, depending on the industry of specialization of the enterprise. If the ratio is below 1, this indicates a high level of financial risk, which is associated with the fact that the company is not able to pay bills with stability. If the indicator exceeds 3, this indicates an irrational structuring of capital.
Quick liquidity
The quick (quick) liquidity ratio (from the English Quick ratio, Acid test, QR) is a financial indicator that is equal to the ratio of highly liquid current assets to the list of short-term liabilities or current liabilities. The data is similarly provided by the balance sheet, as for current liquidity indicators, however, the assets do not include a list of inventories, since if they are forced to be sold, the losses from this will be maximum among all funds in circulation.
The quick liquidity ratio is calculated using the following formula:
Kbl = (Current assets - Inventories) / Current liabilities, or
Kbl = (Short-term accounts receivable + Short-term financial investments + Cash)/(Short-term liabilities - Deferred income - Reserves for future expenses), or
K = (A1 + A2) / (P1 + P2)
This ratio shows how capable the company is of paying off current obligations in the event of difficulties arising in the process of selling goods.
Absolute liquidity
The absolute liquidity ratio (from the English Cash ratio) is a financial indicator that is equal to the ratio of money and short-term financial investments to current liabilities (or short-term liabilities). Similarly with current liquidity indicators, the report is taken from the balance sheet, but only cash or funds that are equivalent to it are taken into account as assets. This coefficient is calculated using the formula:
Cal = A1/(P1+P2)
Cal = (Cash + short-term financial investments) / Current liabilities
Cal = (Cash + short-term financial investments) / (Short-term liabilities - Deferred income - Reserves for future expenses)
The ratio is considered normal if it is not lower than 0.2, that is, theoretically there is the potential to repay 20% of urgent obligations daily. It makes it clear which part of the short-term debt the company can repay as soon as possible.
Market liquidity
A highly liquid market is a market where transactions for the purchase and sale of goods rotating on the market are regularly concluded in sufficient volume, and therefore the difference in the bid prices for purchase (demand price) and sale (ask price) is small. Each individual transaction concluded on such a market usually does not affect the pricing policy of goods.
In general, market liquidity is an indicator that the stock or foreign exchange market has, and which indicates the degree of saturation of the most liquid financial products. Simply put, the liquidity of a market or stock indicates how high the level of demand of the market or stock is before participants or the level of financial turnover of the constituent financial commodities in the market. If a stock market is highly liquid, it means that there is active trading of stocks that are in high demand in the buying and selling process. In this case, the shares have high liquidity. In particular, this applies to leading companies in production and sales, which are also called “blue chips”. The financial condition of such companies amounts to millions of dollars, and therefore they have such powerful financial potential that they are able to withstand downturns in the economic system and the consequences of protracted crises.
A narrow market is generally considered to be the antithesis of liquid markets. A narrow market is a market where financial products of various categories are concentrated and have low levels of supply and demand. Enough a shining example This type of market is considered to be the real estate market. Usually, when a person invests money in it and wants to return it, he is faced with the fact that finding a buyer usually takes quite a long time.
The liquidity of the product has the same meaning. However, what distinguishes it from the market is that the liquidity of financial goods is influenced by narrowly focused, specific and unique factors, in contrast to the market, where its liquidity would be influenced by their characteristics.
If we take shares on the stock market as an example, we can see that their liquidity itself will be determined by the level of the spread, the ability to quickly conclude purchase and sale transactions, as well as the significant difference between supply and demand. The essence of the liquidity of shares is that they have the ability to quickly turn into money, so their owner does not have to wait long for the transaction to be concluded.
It turns out that the characteristic that determines the liquidity of shares immediately affects the volume of supply and demand, and vice versa - supply and demand for various types of shares determines their liquidity. Partially, supply and demand characteristics, spread size, and trading volume influence market liquidity. Therefore, it is logical that investors prefer assets with high liquidity, which also guarantees brokers reliable profits.
The term liquidity of a market or financial instrument is used to describe the frequency and size of the volume of trading that occurs. Markets that provide liquidity are called liquidity pools.
To carry out the process of selling or purchasing a financial document, there must be a buyer who expresses a desire to buy it. A high liquidity indicator means that quite a large number of market participants want to act as a buyer in the act of purchase and sale. A high level of liquidity can be achieved both by using the services of individual traders who are ready to act as counterparties, and through the influence of large owners of financial documents who would express a desire to take part in the transaction.
Market liquidity provides benefits to each market participant, in particular because it generally reduces the level of risk and offers a greater range of options for buying or selling at a desired rate. pricing policy. The demand for high liquidity ratios is one of the key points, which bring benefits in online trading for economic system. The trading price is reduced, allowing traders to engage in trading with much less capital without having to deal with huge costs due to spreads.
Liquidity of securities
The stock market liquidity indicator is most often assessed according to the number of transactions that take place there (trading volume) and the size of the spread. Spread is the difference between the highest prices for buy orders and the minimum high prices for sell orders (which can be seen in the order book of trading terminals). How large quantity transactions and the smaller the difference, the greater the liquidity indicator becomes.
There are two main ways of concluding transactions:
- Quoted - in which a person places his own orders for sale or purchase, indicating the desired price immediately.
- Market - placing an order so that they are instantly carried out according to market orders with current prices for demand or supply (satisfying quotation orders with the best price offered).
The quotation order creates instant market liquidity. In it, the author indicated the volume, an acceptable price from his point of view and is waiting for his request to be satisfied, which allows other trading participants to sell or buy a specific number of assets at any moment at the price that was agreed upon by the author. The more the author has placed quotation bids for the assets being traded, the higher his instant liquidity is.
The function of market orders is to form an indicator of market trading liquidity. Here the author indicates the volume, but the price is formed automatically based on the best price indicators from the current list of quotation orders. This gives authors the opportunity to enter into as many trading transactions as possible to buy or sell a certain amount of an asset. The more market orders for an instrument arrive, the greater its trading liquidity.
Liquidity of money
As for cash, its liquidity is the ability to use it as cash and pay payments, as well as keep the nominal value unchanged.
Most often, money is the owner of the greatest liquidity based on the framework of a particular economic system. However, they are not always easy to exchange for goods. For example, the list of reserve requirements of central banks includes a refusal to put into circulation all bank funds without exception. A change (both upward and downward) in the size of reserve requirements constrains or releases a certain amount of money corresponding to the requests.
It is generally accepted that the list of properties of money includes “perfect liquidity”, that is, they can be exchanged for goods at any time, and this can happen in an extremely short time. It is money, much more than other means, that is protected from the risk of fluctuations in value. It is worth noting that the level of profitability of an asset depends on the level of liquidity: the higher the first indicator, the lower the second.
The liquidity of each element (type) of money is not the same. For example, money from a current deposit is much more liquid than securities that may be sold on the stock markets.
Bank liquidity
When a bank issues a loan, the amount of money stored there decreases. And the more funds he issues, the greater the risk becomes that there may not be enough funds to return the deposit. In such situations, they speak of a decrease in the bank’s liquidity level.
Several mandatory reserves serve to increase it. In addition, the bank is also able to approach the central bank and ask for a temporary loan, which will be considered as additional liquidity. If banks have excess liquidity, this encourages them to place funds, even taking into account securities. A decrease in the bank's liquidity level leads to the sale of the lion's share of assets, including securities.
Net working capital
Clean working capital used to maintain the financial stability of the company, because exceeding the level working capital above short-term liabilities will mean that the company is able not only to pay off the entire list of its short-term obligations, but is also able to expand its activities using its own reserves.
The optimal amount of accumulated working capital in pure form directly depends on the narrowly focused features of the enterprise’s activities, including the scale of the company, the volume of sales of goods, the speed of turnover, inventories and the size of accounts receivable. If working capital is insufficient, this means that the company is unable to pay short-term obligations on time.
If there is a significant excess of net working capital over the optimal requirement, this indicates that the enterprise’s resources are being used irrationally. Extremely important for analytics has a process of considering the growth rate of a company's working capital based on inflation rates.
We briefly examined what liquidity indicators are: enterprise liquidity, current, quick, absolute liquidity, market liquidity, securities, money and bank liquidity, net working capital. Leave your additions and comments to the article.
Liquidity is the ability to “get rid of” a certain product as quickly as possible by exchanging it for a cash equivalent. If a product is in demand on the market and sells well, this indicates its high liquidity. Depending on the speed of sale of a product, its liquidity will be determined as high, medium or low.
It seems that all the basic definitions and concepts are given in simple language– this is approximately how Wikipedia describes the concept of “liquidity”. Next, we will consider separately the liquidity of shares, enterprises and real estate, as well as the factors that influence and shape liquidity. We will separately consider liquidity ratios and methods for assessing the solvency of a business.
Highly liquid and low liquid: what is the difference
All goods can be considered highly liquid or low liquid, depending on the speed of their sale. Therefore, from the point of view of receiving money as quickly as possible, securities and bank deposits are highly liquid goods, because sometimes a couple of minutes are enough to convert them into banknotes. Real estate will be “illiquid” in comparison, and the more expensive it is and the more difficult it is to sell, the less liquid it will be considered a product.
Liquid currencies are the most popular banknotes used throughout the world or in a certain large region to carry out purchase and sale transactions. The liquidity of a currency is affected by the economy of the countries in which this currency is listed as the main or reserve currency. The most liquid currencies in the world:
- U.S.
- Euro.
- British pound.
- Japanese yen.
- Swiss frank.
- Australian dollar.
- Canadian dollar.
The ruble is currently an illiquid currency.
Liquidity of securities: what makes blue chips special
Securities are bills of exchange, shares, bonds and others. monetary documents certifying some property rights its owner (for example, the right to pay dividends - part of the company’s profit). Being a highly liquid commodity, securities in their group are also divided into “liquid” and “illiquid”. Illiquid goods are rarely in short supply - there is little demand for them, and few people buy them.
Securities in their own hierarchy are divided into "blue chips", second-tier securities, third-tier securities and so on. In simple terms, the further echelon the securities belong to, the lower their liquidity. Such securities are difficult to sell at a good price - as a rule, you can lose about a quarter of their original value by selling them.
“Blue chips” is a concept that came from American casinos. There, blue chips have the highest monetary denomination. Today, this is what they call the most liquid shares - shares of large companies that are in the top thirty largest companies in their country or in the world (depending on which market we are assessing).
In our country, “blue chips” mainly include shares of banks and gas and oil production and processing companies: Rosneft, Gazprom, LUKOIL, Sberbank. In America, blue chips are concentrated in the IT sector - these include securities of Google, Microsoft, Facebook and a number of other corporations.
Business liquidity: what it depends on
The liquidity of an enterprise is a very important indicator of its solvency and general condition. IN economic analysis An important role in the success of a company is played by balance sheet liquidity - the company’s ability to timely distribute cash flows to pay off debts. Simply put, the larger the company’s “golden parachute” of free funds, which it can redistribute to eliminate problems, the higher the liquidity of such a company’s balance sheet. Investors will invest money in such a company.
The property of an enterprise is divided into assets and liabilities.
Assets can be:
- highly liquid (investments and finance).
- quickly sold (short-term debts).
- negotiable (sold slowly).
- non-negotiable (sold very slowly).
Liabilities can be:
- urgent.
- current.
- long-term.
- the company's own capital.
Business liquidity analysis in general terms
To analyze the liquidity of an enterprise, the so-called liquidity ratios are used:
- current ratio.
- quick ratio.
- absolute liquidity ratio.
The current ratio (also known as the coverage ratio) determines the ratio financial assets the company and its short-term liabilities. It is believed that ideally this coefficient should be equal to 2.
The quick liquidity ratio is calculated as the sum of all highly liquid assets divided by the company's short-term debts. Quick liquidity is an indicator of solvency. Ideally, its indicator should be equal to 1.
The absolute liquidity ratio varies from 0.05 to 0.1 and shows the reliability of the borrower.
Real estate liquidity: how is it determined?
Real estate itself has low liquidity. However, if we consider, for example, luxury house luxury class and a new building in the budget segment on the outskirts of a large city, the new building will have much greater liquidity, since many more people can buy apartments in it, and it will be easier to sell them.
In the sale of real estate, the same rules apply to determine liquidity - the easier it is to sell, the higher the liquidity.
Why is liquidity so important?
Potential investors are most interested in liquidity. On the one hand, they must be confident that the project can be profitable and their securities will increase in price. On the other hand, loss control rules force investors to choose projects whose securities will be easier to get rid of in case of unforeseen difficulties.
The stock market periodically experiences crashes, and traders whose portfolios contain only low-liquid stocks are forced to look at falling prices and count their losses, unable to get rid of illiquid securities.
Liquidity is a characteristic of an enterprise’s assets that can determine the possibility of their full sale at market value.
In other words, we can talk about high speed circulation into cash.
Description of liquidity in simple words
Liquidity - information from Wikipedia
The possible level of liquidity can be identified by the ratio of the volume of liquid funds that are at the disposal of the organization to the amount of existing debt, which is a balance sheet liability. The liquidity of an individual enterprise can be synonymous with its stability.
Businesses can be:
- highly liquid,
- low liquidity,
- illiquid.
And the easier it is to exchange the company’s existing assets, based on its full value, the higher the level of its liquidity will be. In the case of goods, liquidity will be equivalent to the speed of selling products at nominal value, without resorting to the use of additional discounts and promotional offers.
Liquidity and assets of the enterprise
If we analyze the level of liquidity of the assets of an individual enterprise, which are reflected in balance sheet, then the most liquid of them will be the funds in the accounts and cash registers of the enterprise. The least liquid assets include real estate that is under construction, as well as finished buildings and structures.
Machinery and equipment, as well as stocks of goods and raw materials in warehouses, will be priced a little more expensive.
Highly liquid assets include government securities, bank bills, etc. This also includes issued loans, as well as corporate securities. In this case, we mean the company's shares that are quoted on the stock exchange.
The concept itself liquidity can be used in relation not only to enterprises (as noted above), but also to banking organizations, securities and even to the entire market. For determining objective assessment liquidity is used liquidity ratios .
Liquidity ratios are financial indicators that can be calculated according to the provided financial statements of an enterprise in order to further determine the company's ability to repay debt using current assets.
Types of liquidity
Liquidity can be classified according to various criteria. Depending on this, this indicator is divided into two groups.
By sources
IN in this case liquidity can be accumulated and purchased. The first includes funds held in savings in cash registers or correspondent accounts, as well as all available cash. This also includes assets that can be converted into cash. Such assets include shares and other securities.
Purchasing liquidity includes interbank loans, as well as possible loans, which can be provided by the main banking regulator in a particular country. In Russia, such a financial institution is the Central Bank.
By urgency
Everything is much simpler here. This is about possible date converting existing assets into cash. Based on these characteristics, liquidity can be instant, short-term, medium-term or long-term.
This classification is relevant solely for determining the level of liquidity of a banking organization. In the case of another enterprise, a slightly different definition scheme will apply.
Do you know how easy it is to cash out your own funds? It all depends on the form in which they are stored. Liquidity of money is a basic concept in accounting, finance and investing. It reflects the ability of assets to transform from one form to another. A desirable outcome for any company is that this operation occurs quickly and without significant financial losses. Therefore, the liquidity of which is considered absolute is still so important. We will begin our article with a definition of this concept. Then we move on to consider the types of enterprise performance indicators and the role of banks in maintaining a certain level of liquidity.
Definition of the concept
Liquidity of money in accounting characterizes the ease of converting the assets at the disposal of an enterprise into cash. The latter can be used to buy anything at any time. money concerns only cash. Savings in a current card account cannot be used to buy vegetables from a farmer at the market. Money on deposit is even less liquid. This is because they cannot be obtained instantly. In addition, early termination of an agreement with a bank is often fraught with additional financial losses.
Money, liquidity and asset types
The funds available to the enterprise take the following forms:
- Cash.
- Funds in current accounts.
- Deposits.
- Savings Loan Bonds.
- Other securities and derivative banking instruments.
- Goods.
- Shares of closed joint stock companies.
- Various collectibles.
- Real estate.
Please note that this list is arranged in descending order of their liquidity. Therefore, you need to understand that the presence of real estate is not a guarantee of protection against insolvency in times of crisis, since it may take weeks, if not years, to sell it. Making a decision to invest money in any type of asset should be based on its level of liquidity. However, some valuables do not need to be sold to get quick cash. Money can be borrowed from a bank using, for example, real estate as collateral. However, such an operation is associated with financial and time costs. Therefore, cash liquidity is the benchmark for all other types of assets.
In accounting
Liquidity is a measure of a borrower's ability to pay its debts when due. It is often characterized by a coefficient or percentage. Liquidity refers to the ability of an enterprise to pay its short-term obligations. The easiest way to do this is with cash, as it is easily converted into all other assets.
Liquidity calculation
There are several ways to calculate this indicator on the balance sheet of an enterprise. They include the following:
- Current ratio. It is the easiest to calculate. This coefficient is equal to the result of dividing all by the same liabilities. It should be approximately equal to one. However, you need to keep in mind that some assets are difficult to sell for full value in a hurry.
- Quick ratio. To calculate it, inventories and receivables are subtracted from current assets.
- Operating cash flow ratio. The liquidity of money is considered absolute. This indicator is calculated by dividing available cash by
Using odds
For various industries and legal systems use individual indicators correctly. For example, businesses in developing countries need greater levels of liquidity. It's connected with high level uncertainty and slow return on investment. For an enterprise with a stable cash flow, the quick ratio is lower than for an Internet startup.
Market liquidity
This concept is key not only in accounting, but also in banking. Insufficient liquidity is often the cause of bankruptcy. However, too much cash can also lead to it. The lower the liquidity of assets, the greater the income from them. Cash does not bring it at all, and the interest on money in a current account is usually more than modest. Therefore, enterprises and banks strive to reduce the number of highly liquid assets to the required level. Has a slightly different meaning this concept regarding stock exchanges. A market is considered liquid if securities in it can be sold quickly and without loss in their prices.
conclusions
Liquidity is an important concept for both large corporations and individuals. A person can be rich by counting all the assets he owns, but fail to pay off his short-term liabilities on time because he cannot convert them into cash on time. This also applies to companies. Therefore, it is so important to understand what liquidity is and acquire assets in accordance with its normal level for the industry and the state.
