Do you know how easy it is to cash out your own funds? It all depends on the form in which they are stored. The liquidity of money is a basic concept in accounting, finance and investing. It reflects the ability of assets to change from one form to another. Desirable for any company is the outcome when this operation occurs quickly and without significant financial losses. Therefore, cash is still so important, the liquidity of which is considered absolute. We begin our article with a definition of this concept. Then let's move on to considering the types of assets, the financial performance of the enterprise and the role of banks in maintaining a certain level of liquidity.
Definition of concept
The liquidity of money in accounting characterizes the ease of converting the assets at the disposal of the enterprise into cash. The latter can be used to buy anything at any time. The absolute liquidity of money concerns only cash. Savings on the current card account cannot be used for purchasesvegetables at the farmer's 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.
- Current account funds.
- Deposits.
- Savings bonds.
- Other securities and derivative banking instruments.
- Products.
- Shares of closed joint-stock companies.
- Various collectibles.
- Property.
It should be borne in mind that in this list the company's assets are arranged in descending order of their liquidity. Therefore, it must be understood that the presence of real estate is not a guarantee against insolvency in times of crisis, since it can take weeks, if not years, to sell it. The decision to invest money in any type of asset should be based on the level of its liquidity. However, some valuables do not need to be sold to get cash quickly. Money can be borrowed from a bank secured by, for example, real estate. However, such an operation is associated with financial and time costs. Therefore, the liquidity of cash is the benchmark for all other types of assets.
In accounting
Liquidity is a measure of a borrower's ability to pay its debts on time. It is often characterizedratio or percentage. Liquidity refers to the ability of a company to pay its short-term obligations. The easiest way to do this is with cash as it is easily convertible into all other assets.
Calculation of liquidity
There are several ways to calculate this indicator on the balance sheet of an enterprise. They include the following:
- Current liquidity ratio. It is the easiest to calculate. This ratio is equal to the result of dividing all current assets by the same liabilities. It should be approximately equal to one. However, keep in mind that some assets are difficult to sell for full value in a hurry.
- Quick ratio. To calculate it, inventories 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.
Use odds
It is correct to use separate indicators for different industries and legal systems. For example, businesses 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 a stable cash flow, the rate of quick liquidity is less than for an Internet startup.
Market Liquidity
This concept is key not only in accounting, but also inbanking activities. Lack of liquidity is often the cause of bankruptcy. However, excessive amounts of cash can also lead to it. The lower the liquidity of assets, the greater the income from them. Cash does not bring it at all, and the interest on money in a checking account is usually more than modest. Therefore, enterprises and banks tend 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 losing their prices.
Conclusions
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 not be able to pay off his short-term obligations on time, because he will not be able to convert them into cash on time. 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.
