FeaturesLiquidity: What Is the Indicator, Types, and Coefficients?

Liquidity: What Is the Indicator, Types, and Coefficients?

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When we invest in a financial instrument, a company, or real estate we want to be sure that we won’t lose capital and will be able to return it at any time. That is why it is important to pay attention to the liquidity of an asset. What is it and how to define it?

What Is Liquidity?

Liquidity in economics is the ability to quickly sell an asset at a market price and turn it into money.

An asset is any resource that belongs to a company or person (money, real estate, transport, goods, intellectual property, etc.).

In terms of speed of circulation of property in money the asset can be highly liquid, low-liquid and illiquid. Accordingly, the easier and faster an asset can be sold at market value, the higher its liquidity, and vice versa.

Areas of Application of the Index

Company Liquidity

Assessment of a company’s liquidity, be it a bookmaker Senegal or a marketplace, is one of the most important indicators of the company’s financial condition. Management and potential investors should always know the liquidity of the company in order to understand whether the company will be able to quickly pay its creditors in emergency situations.

How to assess the financial liquidity of a company?

First step. Divide the company’s assets into four groups:

  • A1 – the most liquid assets (money on accounts and short-term financial investments).
  • А2 – quickly realizable assets (short-term accounts receivable).
  • А3 – slow assets (inventory, long-term accounts receivable).
  • А4 – hard-to-realize assets (non-current assets).

Second step. Divide the company’s liabilities into the following categories:

  • P1 – most urgent liabilities (accounts payable).
  • P2- short-term liabilities (short-term loans and credits, dividends and other income due to participants).
  • P3 – long-term liabilities (long-term credits).
  • P4 – fixed liabilities (deferred income, provisions for future expenses and payments).

Third step. Correlate the assets of the firm with the sources of funding.

If the ratios A1 ≥ P1, A2 ≥ P2, A3 ≥ PZ, A4 ≤ P4, then the company is considered liquid. Otherwise, the company’s management must urgently change its business policy. For example, to try to increase working capital and profits or reduce the amount of borrowed funds. You can also resort to reducing accounts receivable.

Real Estate Liquidity

When investing money in real estate, it’s important to know that not every apartment has a high liquidity. There are many factors to consider: the infrastructure of the area, the distance to the city center, the type of property, the layout of the apartment, etc. Accordingly, each of these parameters in the aggregate will influence both the value of the real estate, and the speed of the transaction of sale. Therefore the slower the sale of the object, the lower its liquidity at the market.

Money Liquidity

As far as money is concerned, cash in countries with stable economies is the most liquid instrument. It allows you to pay anywhere freely and is also capable of maintaining its face value unchanged.

Keep one thing in mind: the liquidity of finances changes over time. This is directly linked to inflation. Prices of goods always increase at the same time as the purchasing power of the national currency decreases. This is why you will need more and more money to buy the same things every year.

Asset Liquidity

To identify the degree of liquidity of an asset, it’s important to understand how quickly we can sell it. Generally, assets have different levels of liquidity.

The most liquid assets are considered to be cash, government securities, and current short-term debt of the company. Resources with low liquidity can include some corporate stocks, inventories of goods and raw materials, as well as buildings and constructions.

What Types There Are

Any commodity, property or enterprise can be evaluated in terms of liquidity. Let’s look at the main types of liquidity and what they mean.

Current

The main objective of current liquidity is to reliably reflect a company’s financial ability to repay all its debts with highly liquid assets, primarily cash.

Fast

A quick liquidity ratio is needed to understand how soon a company will be able to close its credit obligations with the products and raw materials it has on hand.

Absolute

Absolute (or instant) liquidity gives the organization’s management an understanding of whether the company will be able to pay off its debt with available cash.


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