In the business and corporate world, liquidity is a frequently used term. But you know what it is definition of liquidity in finance and which aspects are very important? Read on, because in this article we will tell you all about it.
Whether you want to learn how to better control your personal expenses, or you are starting a new adventure, understand more about the concepts of economics it will be of great use to you. With the knowledge you will find here, you will be able to plan a strategy that will allow you to achieve the goals you have set for yourself.
What is the definition of liquidity in finance and which aspects are very important?
What is the definition of liquidity in finance?
Liquidity is a very important concept in finance, both personal and in a company or business. This refers to the ability we have to convert our assets into cash quickly and without losing their value, to be able to cope with financial responsibilities that arise in the short term.
The degree of liquidity of an asset will depend on two fundamental elements. The first is the opportunity to sell it , which is related to market supply and demand. And the second is the simplicity or complexity of the buying process as such.
So when we say that an asset is very liquid, that is it implies that its sale will be easy , fast and that you do not risk much when you sell it, because its value will not change. Due to these characteristics, cash is the most liquid asset that a company or a person can own.
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The cash would be followed, for example, by the balance of an easily accessible savings account. Conversely, life insurance or even gold are illiquid assets, as it takes a long time to find a buyer willing to pay their market value.
Terms with which liquidity is often confused
There are some terms associated with finance and economics that could be confusing when it comes to correctly understand what liquidity is . Next we will leave you their definitions, so that you can compare them with the definition of liquidity and that you have no doubts:
- Solvency: is the ability of a company to generate funds with which to meet its payment obligations agreed with third parties under certain conditions (generally, in the long term). It has a lot to do with the organization's reserves.
- Profitability: it is the measure that compares the level of profit obtained with the resources used to obtain it. This is something you should keep in mind if you want to delve into the theory of loanable funds.
Important aspects of liquidity in finance
To better understand the importance of liquidity, you need to keep in mind that every business needs liquid assets , but also illiquid assets. The first will allow you to solve any crisis in the short term, while the second will allow you to obtain profits and greater return on capital.
Therefore, a company's liquidity becomes more important in times when bank credit is scarce . In this situation, and depending on the state of Universal Banking, it is extremely useful to have highly liquid assets available to be able to resolve any unexpected inconvenience, or process a last-minute transaction.
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Just in those moments, it is essential that you can calculate the liquidity of your company . This can be done quickly and easily by dividing the current assets (which is the sum of the company's most liquid assets) by the current liabilities (set of debts that must be paid in the short term).
When performing the above calculation, if the result is less than one, it means that your company does not have enough liquidity to meet the debt it has at any given time. Even if you have a lot more debt than debt, you have to that it is liquid to be able to weld it quickly.
The ability of a company to pay its debts and increase its capital and reserves is essential for its survival in the market. Therefore, it is important for a company to set clear goals and plan the most appropriate marketing and business strategies to achieve them.