Whenever you are looking for a way to easily convert your current assets and securities into hard cash in the market without hurting your financial standing and reputation in the market, it is known as liquidity.
Liquidity: Understanding how it Works?
Liquidity is a financial term that explains how easily your businesses can purchase and sell your existing assets in the market at their intrinsic values. As you know that cash is known as a universal liquid asset; therefore, it is easier to convert it into assets than the other way around at any time.
For example, if you wish to buy a television for a thousand dollars, it is easier to go and get it in cash, right? However, what if you do not have any hard cash in hand but own a rare collectible item that is worth a thousand bucks?
Well, it is highly unlikely that you will be able to pique anyone’s interest to get into old-style barter trade with you and exchange a collectible for a Television.
Therefore, it is wise for you to first try and find a buyer for your collectible, sell it and once you have the cash, get yourself a television.
Now let us look at an alternative scenario when you actually need cash right now?
We know it is not an easy task to find a buyer with interest in collectibles, so what do you do? The only option you have is to get someone interested in offering a discount on the item, so they may consider it a good bargain, even when they really do not need the collectible.
How Do You Measure Liquidity
There are two ways you can measure the liquidity of your company’s assets.
- Market Liquidity
If you wish to describe the limits, a market applies on an asset to sell or purchase at a transparent and stable rate/cost.
- Accounting Liquidity
Suppose you are looking for a way to gauge the convenience with which you can fulfill your company’s financial obligation by selling the liquid assets. In that case, accounting liquidity is what you measure.
For example, do you have enough money to meet your debt commitments by the dates you have to pay them off?
How Do You Measure Liquidity?
There are a couple of formulas that we are going to share with you here that will allow you to gauge the liquidity of your assets. That said, there is one condition that is to achieve a ratio of over one or more.
- How to Measure your Current Ratio?
In order for you to gauge the current ratio of all your assets, there is a least strict and a simple way to do it. You can use the following formula to take care of this.
The formula is to divide your current assets with your current liabilities.
- How to measure your Quick Ratio?
This one is a bit stricter in rules and involves your non-liquid assets as well as your inventories. Moreover, you can count on your short-term investments along with your accounts receivables too.
So the formula will add your cash, short-term investments and account receivables and divide them with all your current liabilities.
For variation, you can deduct your inventory from the current assets to be slightly generous.
