The concept of liquidity, types and how to calculate
The meaning of the word liquidity is not as confusing a term as it might seem. In essence, liquidity is the ability of something (an asset) to quickly turn back into money without losing value. Liquid, respectively, – convertible into money. Values are high, low and illiquid. The faster and easier an asset can be exchanged for money, the higher its liquidity.
The concept is widespread and applicable to any object – including real estate, stocks, enterprises, markets, etc. There is also the concept of “liquid value” – this is an indicator (in monetary terms) of the appraised object, reduced by the costs associated with its sale. Advertising, storage, delivery – all these are costs that reduce the real cost of the product in the end.
Essence and concept of liquidity
Liquidity determines how long it takes to sell a certain commodity (asset) while its market price is maintained. A short term means high liquidity, and vice versa, a long term means a shortage of liquidity.
Liquidity in business
When we talk about the liquidity of an enterprise, we mean the ability to pay off the company’s debt in a short time. The degree of liquidity in this case is the ratio of funds (assets) to debts (liabilities).
Investment liquidity
Investments can also be liquid – this depends on their ability to be sold at the original price in a short period of time. The main criterion for assessing liquidity, including for investments, is the very time it takes to sell an investment on the market. There are several types of objects according to this characteristic:
urgent liquidity – with a conversion period of not more than 7 days;
highly liquid — with a conversion period of 8 days to a month;
medium-liquid — the period of their conversion is from 1 to 2 months;
weakly liquid — from 4 to 6 months;
hard-to-liquid – all objects with a conversion period of more than six months.
Liquidity classification
Product liquidity
A liquid commodity is a commodity that can be quickly sold without loss of profit. The level of liquidity is defined as follows: the faster this can be done, the more liquid the product. A product with absolute liquidity can be sold without loss in the shortest possible time at any time.
Balance liquidity
This is the name of the organization’s ability to repay its debts (financial obligations) on time with the help of those assets that the company has in stock. How to calculate balance sheet liquidity? Contact an accountant or an accounting program: it will calculate the ratio of real assets and existing financial obligations.
Enterprise liquidity
The concept of liquidity implies the ability to quickly and profitably repay all the financial obligations of the enterprise, that is, its current debt.
Market liquidity
The concept of liquidity means the presence in the market of regular buyers and sellers, including specific assets (products or services).
Bank liquidity
The concept of bank liquidity is easy to explain: if a bank can pay off all its obligations (debts), it has high liquidity. Bank liquidity risk is the probability of late payments, which is always specified in the contract.
Choosing a bank to deposit
There are basic criteria for choosing a bank, but the main one is your expectations. Decide what exactly you expect from the bank: reliability, profitability, service – the final choice depends on your priorities.
Basically, services in banks are almost the same, but for different categories of citizens they may differ. So, for example, for pensioners there may be special conditions for receiving pensions or social benefits – not every bank has the right to issue them.
In the end, it’s not even a fact that you need a bank: if you want to invest, then, in addition to a deposit, you can do this by buying securities – this is even more profitable in most cases.
So, we choose according to the following factors affecting the liquidity of the bank:
compare current offers;
checking the license
we study accessibility (online, bank branches, ATMs);
evaluate reliability;
specify the balance sheet profit (should be stable);
Liquidity of securities
The term works in a similar way – it shows the ability of a commodity (papers, in this case) to be sold at market value.
Types of liquidity of the enterprise
Liquidity is precisely an economic indicator that clearly shows how solvent and stable an enterprise is. The higher the indicator, the faster the potential rate of repayment of debts, the better, respectively.
Current liquidity ratio
The standard or current ratio characterizes the state of affairs in the future 30 days. Thanks to this indicator, it becomes clear to what extent the bank is able to fulfill its obligations (presented within a month). We consider the amount of assets available for conversion into real money (this is the liquidity of assets), and divide by the sum of all accounts with terms up to a month. After that, we multiply the figure by 100% – the current liquidity ratio must be at least 50.
