What is Liquidity ?
Definition of Liquidity
Liquidity is the availability to quickly convert or transform assets and securities into cash.
For liquid assets, there has to be a permanent active market i.e. there should be available active buyers and sellers.
Some assets are more liquid than others.
Brief Explanation of Liquidity
Example of liquid assets include cash in hand, investments like bonds , securities , mutual funds ,gold etc.
Example of non-liquid asset may include real estate investment as it would take time to be converted into cash.
ADVANTAGES OF LIQUIDITY:
- Easy and quick access to cash at the time of need.
- More liquid investments are less risky as they are more conservative.
- You can easily withdraw and re invest in more profitable stocks.
- It enhances your profile.
DISADVANTAGES OF LIQUIDITY:
- Investing in more liquid investments means low return because of their conservative terms.
Companies keep a portion of their assets as highly liquid. It is to meet the urgent needs at a given or uncertain time.
Numerous Liquidity ratios are calculated as follows:
Current ratio =Current assets / Current liabilities
- It shows the ability of company to cover it’s short term liabilities.
- If the ratio is above than 1,means company is well able to pay it’s dues .
- If less than 1 means a sign of trouble.
QUICK RATIO/ACID RATIO:
This ratio is even more liquid in nature because it includes only cash , securities and receivables.
It does not include inventory as in in current ratio because inventory in this case is not considered to be very liquid.
Quick Ratio = (Current assets- inventory)/Current liabilities
This ratio also needs to be above 1 to be able to pay the dues when fall.
These days companies invest most of their capital and keep a contract with banks that whenever urgent cash is required the bank arranges the cash for them.