Current market conditions of the economy are specific and are characterized by the influence of the crisis on the activities of companies. Any entrepreneur and businessman wants to deal only with companies that can fulfill their obligations on time. Therefore, the answer to the question: "What is liquidity?" is pretty significant. In this regard, it is necessary to clearly understand the main parameters characterizing the financial condition of the company. Consider the concept of liquidity: what is it in a simpler sense, what are the types and which indicators are used to evaluate it.
The definition under study indicates the ability to quickly sell an asset (at a price as close to market as possible). There is another meaning - the ability to easily turn into money supply. In the process of researching the state of the financial sector of the company, the concept of current and absolute liquidity ratio is mentioned.
Liquidity concept
So what is liquidity? This issue is very relevant today.
Liquidity is a special term that characterizes the value of financial assets. It shows the ability of assets to be sold at market prices. That is, liquid value means that which is converted into cash.
Representatives of different industries have different assessments of the standards for this indicator, based on the prevalence of certain assets, their current market value. An asset liquidity indicator can indicate the level of security in the event of a market crisis.
The studied concept allows you to most accurately determine the financial position of the company, as well as to learn the solvency of the organization.
It gives an idea to creditors and investors about the state of the company regarding the ability to pay off its debts.
The meaning of liquidity
The indicator is very important for investors and counterparties. Indeed, the magnitude of risk and profitability depends on the liquidity of assets. And the quality of the investment portfolio is determined by the tactics and strategy of investments, not to mention financial stability.
Analysis objectives
The purpose of the analysis when researching what liquidity is, is to assess the ability of the company to fulfill its short-term obligations through existing current assets on time and with specific amounts.
The studied concept is a central indicator of the analysis of the financial condition of the organization. It implies the ability of the company to pay its debts on time and assesses the degree of bankruptcy of the company. Liquidity analysis is a determining factor in predicting the activities of a company.
Balance sheet assets by liquidity
The ability of working capital to circulate in a short time ensures the solvency of the company in the present and in the future.
The liquidity of the balance sheet reflects the ratio of existing assets to current liabilities, or rather, determines the ability to pay off debts at certain times for the money received from the sale of existing property.
For this purpose, use and allocate 4 groups of assets:
A1 - can be sold as soon as possible (high liquidity);
A2 - sold up to 12 months;
A3 - remaining current assets;
A4 - sold for a very long time.
At the same time, liabilities are grouped according to their maturity:
P1 - urgent obligations to creditors, employees, the state budget, etc., which require quick payment;
P2 - credit and borrowed resources up to 1 year;
P3 - credit and borrowed resources for more than 1 year;
P4 - equity (permanent).
A company will be liquid in the case when the first three groups of assets matter more than the first three groups of obligations, and the last - vice versa.
Various liquidity ratios and balance sheet formulas are used as tools for determining liquidity. They are calculated based on the data presented in the financial statements, using special formulas. Liquidity ratios provide an opportunity to understand whether the company will be able to pay the existing debt without attracting third-party funds, and predict the future financial situation.
We consider these coefficients in more detail.
Coverage ratio (or total current liquidity)
The liquidity ratio (formula for the balance sheet) shows the ability of the company to repay debts that must be closed in the near future. This is the most common liquidity calculation option. Initial information is taken from the balance:
Kp = OA / TO,
where Kp is the current value of the coefficient;
OA - current assets;
THAT - current liabilities.
You can also calculate the indicator using the group notation indicated earlier:
Kn = (A1 + A2 + A3) / (P1 + P2).
Its permissible value is determined by the standard from 1.5 to 2.5. If the indicator value is less than 1, the company cannot consistently fulfill its obligations. However, a number greater than 3 indicates an unreasonable use of available resources.
Quick ratio
It reflects the actual ability of the company to pay debts without using its reserves, for example, in case of problems with the sale of products. The calculation is carried out according to the formula:
Kb = (TA - 3) / TO,
where Kb is the quick ratio;
TA - current assets;
- stocks;
THAT - current liabilities.
Or:
Kb = (A1 + A2) / (P1 + P2).
The indicator should be more than 1.
Absolute liquidity ratio
This is the ratio of cash and non-cash funds that the organization currently has to its urgent debts. In practice, this indicator was not used, since it is customary to invest the bulk of the money in the production process. Moreover, when drawing up loan agreements repayment conditions are provided. However, to calculate a bank loan, you may need to determine it by the formula:
Cal = A1 / (P1 + P2).
In the national economy, the norm is the value of this coefficient, equal to 0.2.
Types of liquidity
Consider the main types of liquidity in relation to different options.
- Market liquidity. It is envisaged that the described market indicator is influenced by the difference between the offer price and demand, the number of goods involved in transactions, and stability when making purchase and sale transactions. The indicator is comprehensively evaluated, since fluctuations in individual market characteristics have little effect on self-sufficiency.
- Bank liquidity. When issuing a loan, the amount of cash that is placed in the bank is reduced. With an increase in the volume of loans issued, the likelihood of defaults increases, which means that the bank's liquidity is assessed as low. To increase it without harming the core business, the bank creates reserves. In difficult situations, banking organizations are able to obtain a loan from the Central Bank and increase their performance.
- The liquidity of the enterprise. Here we are talking about the company's ability to be liable for obligations through the sale of assets at its disposal, as well as by attracting money from outside (loans).
Solvency and liquidity
Solvency implies that the company has sufficient cash or cash equivalents to repay receivables urgently.
What is liquidity? This is the ability of the enterprise to cover debts over a certain period of time, which determines the expected state of payments. It is inextricably linked with the concept of profitability - profitability, the provision of which is possible even with low liquidity. And vice versa: a company that has a high level of liquidity with low profitability may go bankrupt in the near future.
Thus, the concepts of liquidity and solvency are closely related, but at the same time, they have differences from each other.
Strengthening directions
The main ways to increase the company's liquidity are:
- increase in equity;
- realization of a part of fixed assets;
- decrease in excess reserves;
- the possibility of obtaining long-term financing.
To strengthen the solvency of the company it is necessary:
- improving the management of receivables and payables of the enterprise;
- increase in liquidity balance;
- optimization of accounts payable regulation processes is associated, first of all, with cash flow control in settlements: its acceleration is a positive trend in the economic activity of an enterprise.
Acceleration of turnover can be achieved by selecting potential buyers, determining payment terms, controlling the terms of receivables and influencing debtors.
Optimization of accounts payable regulation processes includes:
- the correct choice of the form of debt (bank or commercial) in order to minimize interest payments and the cost of acquiring material assets;
- creation of the most convenient form of bank loan and its term;
- prevention of the formation of overdue debts associated with additional costs (fines, penalties).
The delay in obtaining information on the amounts of debt leads to the fact that the company either remains without the necessary working capital, or is unable to correctly plan the amount of money for future payments.
Conclusion
Liquidity is an important factor in the economic activity of the company, which plays an important role for investors who want to invest their funds as efficiently as possible. But even people who are far from business should understand the basic meanings of this concept in order to trust the investments of trusted highly liquid companies. Liquidity analysis is a measure of the financial ability of a company to pay its debts to creditors, therefore, its analysis and research is a very important stage in assessing the financial situation of a company.