This post addresses many aspects of liquidity.
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What is meant by liquidity?
What metrics can be used to assess improvement ordeterioration in liquidity?
How is liquidity influenced by debt?
How do different types of debt affect liquidity?
How does equity affect liquidity?
How do different types of assets affect liquidity?
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Solution Summary
The solution provides a detailed discussion examining each of the questions about liquidity listed. References are also provided. This solution is written based on 25+ years of professional experience in the accounting industry.
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What is meant by liquidity?
Liquidity refers to how much in cash or other liquid assets a company has available to cover their current obligations. The most common liquid assets of a company include cash, accounts receivables, and inventory, as well as short-term financial assets that are typically in the form of short-term bonds, stocks, and other assets. If the company were to liquidate tomorrow, liquidity would determine if the company would have enough in liquidity to cover their obligations, and would also measure current status. It shows if the company has enough money currently to cover the current expenses and liabilities (loan payments and other obligations) that are now due.
What metrics can be used to assess improvement or deterioration in liquidity?
The most common metrics are financial ratios and are used for the specific purpose of evaluating the level of improvement or deterioration in a company's liquidity. The main ratio used is the current ratio, which is calculated by dividing current assets by current liabilities. If the company has $20 million in current assets and $10 million in current liabilities, the current ratio would be 20/10 = 2, so the current asset ratio would be 2.0. This would be an acceptable current ...
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