What is liquidity in a business? It is defined as, “The ability to pay debts and bills.” In other words, a company’s stock price or market value, as a matter of fact and as perceived by the market participant or buyers, represents liquid assets for that company. Liquidity in a business is determined by the net assets and liabilities less the current value of those assets and liabilities. The difference between net worth and current value, net worth is what investors and banks use to determine the ability of the company to repay its debts and meet its expenses.
Companies have both current and short-term assets and liabilities. Its current market value, or market value today, takes into account the company’s current assets and current liabilities. If the market value today is more than the current value then the company has net worth.
There are two kinds of liquidation: active and passive. An active liquidation is one where the Board of Directors liquidates the business and all of the shareholders are paid off. A passive liquidation occurs when the Board of Directors declares a company bankruptcy and the company are closed. A third kind of liquidation, the unexventive liquidation occurs when the company is not making any dividend payments to holders and is not on the verge of bankruptcy. All three kinds of liquidations have different consequences.
Active liquidations have the effect of selling or transferring assets to minimize debt. A company does not necessarily need to sell all its assets because it can just divert the money earmarked for its debt to assets that will more than likely yield a higher profit. This kind of sale usually happens when the debt to equity ration of a company is poor. Also, if there is an ongoing decline in the economy and business is contracting, a company will be forced into liquidation.
Passive liquidations occur when a business is going through its debt reduction process. A company can reduce its assets by selling or transferring them to debt holders or by exercising options on existing assets. It is important to note that this type of transaction does not have the same effect on the income statement as an active transaction. Passive liquidation usually happens when there are problems with a business’s cash flow, which forces the management to consider other options aside from selling its assets. What is liquidity in a business?
Liquidity in a business can also be measured by how liquid it is on an operational stand. If the company is able to finance operations on hand, it has no need to look for external financing. Also, if the only assets it possesses are its existing fixed assets, it is not imperative for it to raise additional funds since it can easily manage its current assets. On the other hand, if it is resorting to outside financing, it needs to be sure that it has a sufficient amount of current assets to secure the loan and that it can receive the amount it is borrowing. Usually, businesses can obtain funding from banks or other financial institutions through two means, they can acquire loans from the financial sector or seek and secure investors.
Leasing or acquiring additional fixed assets is also a good option for companies to finance their growth. By pooling resources together, it allows each entity to have access to necessary funds in order to grow. What is liquidity in a business? Liquidity in this case refers to the ability of a company to finance operations as expected despite the decline in sales or market values.
In a business, liquidation occurs when the value of the firm’s current assets declines more than the value of its net worth. This situation can be caused by a number of factors. One of these reasons is the failure of a specific market-oriented venture. Another cause can be attributed to the non-availability of raw materials due to oversupply.