Do you know how easy it is to cash your own funds? It all depends on the form in which they are stored. Money Liquidity is a basic concept in accounting, finance and investing. It reflects the ability of assets to transform from one form to another. An outcome is desirable for any company when this operation occurs quickly and without significant financial losses. Therefore, cash is still so important , the liquidity of which is considered absolute. We will begin our article with the definition of this concept. Then we turn to the consideration of asset types , financial performance of the enterprise and the role of banks in maintaining a certain level of liquidity.
Definition of a concept
The liquidity of money in accounting characterizes the simplicity of converting the assets at the disposal of an enterprise into cash. The latter can be used to purchase anything at any time. The absolute liquidity of money applies only to cash. Savings on the current card account cannot be used to purchase vegetables from the farmer in the market. Money on deposit is even less liquid. This is due to the fact that they cannot be obtained instantly. In addition, early termination of the contract with the 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 on current accounts.
- Deposits
- Savings loan bonds.
- Other securities and derivative banking instruments.
- Goods.
- Shares of closed joint stock companies.
- Various collectibles.
- The property.
It should be borne in mind that in this list the
assets of the enterprise are arranged in descending order of their liquidity. Therefore, you need to understand that the availability 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. The decision to invest money in any type of asset should be based on its liquidity level. However, some values do not have to be sold in order to get cash quickly. Money can be borrowed from the bank on bail, for example, real estate. Nevertheless, such an operation involves 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 his debts on time. It is often characterized by a coefficient or percentage. Liquidity is understood as the ability of an enterprise to pay its short-term obligations. The easiest way to do this is with cash, as they are easily converted into all other assets.
Liquidity calculation
There are several ways to calculate this indicator on the balance sheet of the enterprise. These include the following:
- Current ratio. It is easiest to calculate. This ratio is equal to the result of dividing all current assets into the same liabilities. It should be approximately equal to unity. However, it must be borne in mind that some assets are difficult to sell at full cost in a hurry.
- Quick ratio. To calculate it, current assets and receivables are taken from current assets.
- Operating cash flow ratio. The liquidity of money is considered absolute. This indicator is calculated by dividing available cash by current liabilities.
Using odds
For various industries and legal systems, it is correct to use separate indicators. For example, enterprises in developing countries need more liquidity. This is due to the high level of uncertainty and the slow return on investment. For an enterprise with stable cash flow, the rate of the quick ratio is less than an Internet startup.
Market liquidity
This concept is key not only in accounting, but also in banking. Lack of liquidity is often the cause of bankruptcy. However, excessive cash can also lead to it. The lower the liquidity of the assets, the greater the income from them. Cash does not bring it at all, and the percentage of money in the current account is usually more than modest. Therefore, enterprises and banks strive to reduce the number of highly liquid assets to the required rate. This concept has a slightly different meaning in relation to stock exchanges. A market is considered liquid if the securities on it can be sold quickly and without loss in their prices.
findings
Liquidity is an important concept for both large corporations and individuals. A person can be rich if you count all the assets in his property, but fail to pay on time for his short-term obligations, because he can not convert them in time to cash. This also applies to companies. Therefore, it is so important to understand what liquidity is and to acquire assets in accordance with its normal level for the industry and the state.