Liquidity Management in Business and Investing

Updated January 24, 2025

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CFO or Chief Financial Officer — The CFO, or Chief Financial Officer𝕴, is responsible for overseeing the financial operations of a company including the Treasurer, ꦿwho handles liquidity needs (e.g., is there enough cash to pay the bills), and the accountants, who prepare the 10K. Getty Images

Liquidity is a commonly used term in finance. In accounting, it is used to indicate how well-positioned a company is to meet its financial👍 obligations. Liquidity can also refer to the ease with which an asset (like a stock or bond) can be converted to cash at its current price. Liquidity management in investing and business involves minimizing the risks associated with liquidity. In this articl♉e, we focus on liquidity management by using financial statements in business and liquidity ratios in investing.

Key Takeaways

Liquidity Management in Business

Investors, lenders, and managers all look to a company's financial statements using liquidity measurement ratios to evaluate liquidity risk. This is usually done by comparing 澳洲幸运5官方开奖结果体彩网:liquid assets—those that can 澳洲幸运5官方开奖结果体彩网:easily be exchanged to create cash flow—and short-term liabilities. The comparison allows you to dete𓂃rmine if the company can make ex♕cess investments, pay out bonuses, or meet its debt obligations.

Over-leveraged companies must take steps to reduce the gap between the cash they have on hand and their debt obligations. When companies are over-leveraged, their 澳洲幸运5官方开奖结果体彩网:liquidity risk is much higher becaꩲuse they have fewer assets to move around.

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Short-𝓀term liabilities are any financial obligations tha🅰t are due within a year.

While companies and governments with debt obligations face liquidity risk, it's the liquidity of major banks that is especially scrutinized. These firms are subjected to heavy regulation and stress tests to assess their 💞liquidity management because they are considered economically vital in💫stitutions.

Liquidity risk management uses accounting techniques to assess the need for cash or collateral to meet financial obligations. The Dodd-Frank Wall 🌸Street Reform and Consu𝓀mer Protection Act passed in 2010 raised these requirements much higher than they were before the 2008 Financial Crisis. Banks are now required to have a much higher amount of liquidity, which in turn lowers their liquidity risk.

Liquidity Management in Investing

Investors still use 澳洲幸运5官方开奖结果体彩网:liquidity ratios to evaluate the value of a company's stocks or bonds, but they also care about a different kind of liquidity management. Those who trade assets on the stock market cannot just buy or sell any asset at any time; the buyers need a ꦺ𓂃seller, and the sellers need a buyer.

A buyer who can't find a seller at the current price may have to raise the bid to entice someone to sell the asset. The opposite is true for sellers, who must reduce their ask prices to entice buyers. Assets are considered illiquid if they can't be bought or sold at the current price. Having the power of a major firm that trades in large stock volumes increases liquidity risk. That's because it's easier to sell 15 shares than 150,000 shares. 澳洲幸运5官方开奖结果体彩网:Institutional investors tend🦂 to bet on companies that will always have buyers if they want to sell.

Liquid markets are characterized by low or narrow bid-ask spreads. The bid-ask spread refers to🐼 the ᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚhighest price a buyer will pay for an asset and the lowest price a seller will accept.

Investors and traders manage liquidity risk by not leaving too much of their portfolios in illiquid markets. High-volume traders generally want highly liquid markets, such as the 澳洲幸运5官方开奖结果体彩网:forex currency or commodity markets with high trading volumes like crude oil and gold. Smalle💯r companies and emerging tech will not have the type of volume traders need to feel comfortable executing a buy order.

What Does Illiquid Mean?

Illiquidity can refer to the inability of a company to fulfill its obligations or to easily convert an asset to cash. Illiquid companies cannot easily convert their assets to cash when they need it, especially to pay off their financial obligations. Similarly, an illiquid asset, such as a stock, can't easily be sold because there may not be enough buyers who want to buy it at the current (asking) price.

Why Is Liquidity Important?

Liquidity is an🐲 important concept in the financial market. Liquidity indicates how efficiently an asset can be converted to cash. It also outlines how well positioned a company is to convert its assets to cash to meet its financial obligations. Liquidity offers us insight into the stability of financial markets and gives investors and company leaders confidence about the business environment, the economy, and investments.

How Well Positioned Are U.S. Banks?

The Federal Reserve conducts annual stress tests to make sure American banks aren't too big to fail. According to tests conducted by the central bank in 2024, large banks are well-positioned to go through a recession and maintain their minimum capital requirements. The Fed reported that these firms have enough capital on hand despite enduring large losses.

The Bottom Line

Liquidity management is a crucial part of the business and investment worlds. If you run a business or are an investor considering adding to your portfolio, you'll want to review liquidity measures like financial statements and liquidity ratios to see how it is being managed. Doing so can help you make better decisions about the future of your company or your investments.

Article Sources

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