Why is liquidity important?
Many companies fail to take in to account the concept of liquidity and that is why they have to face many financial plan failures in critical times. Lack of understanding the concept of liquidity may cause many problems financially. People usually lose their money, they required in their short term needs, due to improper way of investments.
The most liquid asset is cash, as you can buy anything by it. The stocks traded are considered as liquid because you can easily convert them into cash; as there is always a new investor that might be willing to purchase you shares. Whereas many other assets cannot be easily transform into cash. Private company’s debts and shares are some other investment assets that are usually illiquid. It is impossible to sell such kind of assets without facinga great loss of money during economics crises.
There are two things to consider for liquidity ratio. The first and the foremost thing is that liquidity is good concept for the business world. Despite the fact that, it is very important for those financial banks, which are much influenced by liquidity to cover customer’sexpenses, it is also significant for every kind of business.
Every company has many expenses that are used to run the business. Some of them are just for few days, and others are for longer term. Apart from critical situations, every business should have at least minimum amount of liquidity in order to run the business smoothly.
While considering that cash liquidity is important, for instance you if you are having all your investments in bills which are much liquid, then you can sell them in few hours. While the same things can be sell at homes in 30 to 35 days. That is why; to project the capital might need one year forward.
In the business world, liquidity revolves around you. To manage your money properly you have to consider the importance of liquidity. Liquidity importance can be evaluated with the following factors:
1. Liquidity and investment period
Liquidity would be high of the investment is of shorter time, while for longer term liquidity is much low. Long term investments have stable payouts just as the nature of bonds. In longer term, the rate of return would be much lower.
2. Liquidity and Risk
If the liquidity is high, risk would be high and lower the liquidity, lower would be the risk occurrences.
3. Liquidity and sum
There is an inverse relation between the liquidity and the sum. High liquidity will lead to smaller sum and lower liquidity have higher sum. We need another party to buy our investments on the other side while cashing out for cash. It might be stocks, bond or any type business.
The liquidity importance can be determined by how the investor values such issues. For minimizing the risk in your investment you have to minimize the liquidity to avoid any financial failure in the business world.
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