Liquid items are those that can be sold at market value promptly. When you want to sell machine tools in a plant, you can’t do it quickly or for what they’re worth. The other thing is that money is fully liquid; it doesn’t even need to be exchanged for itself because it’s fully liquid. In this case, both a machine and money are called items of value. A thing that is worth money is called an asset.
Why evaluate the liquidity of a company?
The definition of how It is easy to turn usable assets into money is called liquidity. People can get more cash faster if they can sell their homes as soon as possible at the lowest price. When things go wrong, a company with a lot of cash on hand can keep going by selling some of its assets to pay off its bills faster. A company is said to be “liquid” when it has more assets (like cash and land) than debts.
Fixed assets vs liquid assets: what’s the difference?
There are two main ideas in finance: fixed financial assets and liquid financial assets. There are things that a business owns that won’t be sold for a long time. These are called fixed financial assets. As examples, buildings, tools, cars, land, and equipment come to mind.
Fixed financial assets have these traits:
- Typically long-term;
- Used to produce goods or provide services;
- Valued at cost less depreciation and amortization;
- Not always easy to convert to cash.
Liquid financial assets (or current assets) are assets that can be converted into cash quickly without significant loss of value. What’s liquid assets include cash on hand, securities, inventories, and accounts receivable.
Characteristics of liquid assets:
- Typically short-term;
- They are used for the current operations of the company;
- They are valued at market value;
- Easily convertible into cash.
Types of liquidity and their ratios
This is the balance sheet that is used to figure out the cash ratio, which shows if the company can pay its bills on time. For this purpose, it shows how much the company owes compared to how much cash it has on hand.
Liquidity can be full, fast, or liquid. For each type, there is a variable with a different number. This ratio demonstrates that to completely satisfy its current obligations, the organization is capable of liquidating its current assets. Businesses are more likely to be stable if the number is high. In case the company can’t pay all of its bills on time, this number has to be greater than 1.5. The best number that can be is 2.
The quick liquidity ratio is the amount of short-term debt split by the amount of present highly liquid assets. This is an example of a current product that is not very liquid: stocks. Selling them quickly will not make you any money. Based on the emergency, this number shows how well the current bills can be paid off. Based on the given business, if the number is bigger than 1, it means that the business is stable.
If a company owes money right now and has cash on hand or short-term assets, its absolute liquidity ratio is equal to that ratio. Separating current assets from current bills gives you this amount’s number. Given this range, the number shouldn’t be less than 0.2.
What is a current asset?
Current assets consist of items that the organization planning to sell within the following twelve months. When making something or making a deal with someone, these things are often used: loans, pay, raw materials, short-term high-risk bills, and/or long-term assets. Patents and new ideas, buildings, tools, and long-term purchases are all examples of noncurrent assets. These are items that are utilized and generate revenue for a period exceeding one year. In contrast to current assets, which are liquidated within a brief period, non-current assets are those that are retained for an extended period.
There are four kinds of assets:
- A1: The most flexible assets are cash on hand and short-term financial transactions;
- A2: Short-term bills payable are an example of an asset that can be sold quickly;
- A3: Assets that don’t change quickly, like high-value stocks, long-term debts, and VAT;
- A4: It’s hard to get non-current goods.
What the business owes is the opposite of what it owns. There is money that the company owns, like approved or share capital, and money that it gets, like bank loans. These debts are also broken down into four groups based on how soon they need to be paid:
- L1: The most urgent liabilities: booking of payables;
- L2: Short-term liabilities: immediate credits and refunds and for accounting to all and sundry revenue from that angle;
- L3: Long-term liabilities: perpetual debt;
- L4: Stable liabilities: comes with a delayed payment discount, is accrued in financial assets and accounts, or is categorized for reimbursements in the future.
Different forms of liquidity
A company’s liquidity shows how much its assets are worth compared to its debts. This means that it shows if the company will have enough cash to pay its debts in an emergency. In this situation, the time it takes to sell assets should match the time it takes to pay off debts.
The liquidity of a bank depends on several factors. It usually means how well a bank can pay back people who have deposit accounts with them. Liquidity goes down when a bank lends money. This is because the amount of money in the bank goes down.
Market liquidity. Liquidity isn’t just for businesses or banks; it’s for whole markets, like those for securities, services, and so on. A market has a lot of liquidity if there are lots of trades and not much difference between the prices of buy and sell orders. Also, there should be a lot of these kinds of deals so that none of them have a big effect on the prices of goods.
The liquidity of money is the ability to pay freely with it, as well as its ability to retain its denomination without change. The national currency usually has the most value when the economy of a country is stable.
The liquidity of real estate is the ability to sell it quickly. Real estate is not as easy to sell as cash, securities, or a company’s stock. It can’t be sold quickly because it needs to be valued first, and deals take a long time to complete. The seller may also offer less than the item’s market value to get rid of it quickly.
Conclusion
A company is said to be liquid if it can pay its debts at any time. It is easier for a company to get cash when it has more assets, like money, machinery, buildings, and other structures. There are public accounting reports that can be used to figure out how liquid a company is. Increasing a company’s liquidity means adding to its assets and decreasing its debts. One way to do this is to stop borrowing money.
