Key Takeaways
Liquid assets are easy to turn into cash with little loss in value, making them ideal for covering unexpected expenses. Non-liquid assets are harder to convert into cash and often lose significant value if there are few buyers when you need to sell.
In a liquidity crisis, liquidity problems at individual institutions lead to an acute increase in demand and a decrease in the supply of liquidity, and the resulting lack of available liquidity can lead to widespread defaults and even bankruptcies.
Answer and Explanation: Yes, a company can be profitable but not liquid because of the accrual basis of accounting. In the case of accrued income, prepaid expense, credit sales, etc., there can be a shortage of liquidity. If a company made credit sales then debtors would increase which will make the cash flow negative.
Liquidity provides financial flexibility. Having enough cash or easily tradable assets allows individuals and companies to respond quickly to unexpected expenses, emergencies or business opportunities. It allows them to balance their finances without being forced to sell long-term assets on unfavourable terms.
A strong liquidity position not only helps a company weather economic downturns but also enables it to take advantage of strategic opportunities, such as investments or acquisitions, without risking its financial stability.
Non liquid assets are assets that cannot be sold or converted into cash easily without a significant loss of investment. Some examples of such assets include houses, cars, land, televisions and jewelry.
Poor liquidity, on the other hand, means a business is at higher risk of failing if suddenly faced with unexpected debt, for example, a costly machine repair or a large VAT bill. If the business is unable to convert enough assets to cash quickly to cover the debt it can push it into insolvency.
While it may seem like a company should have to make a profit in order to be considered successful, that's not always the case. Take Amazon, for example. Although it was founded back in 1994, Amazon didn't actually make a profit until 2001. But the company has been a major online retailer for years.
A company's operating cash flow offers a portrait of its day-to-day operating activities: namely, the income from sales and outflows from salaries, vendor fees, lease payments, taxes, and interest payments. A company whose sales exceed its operating expenses is cash flow positive.
Having readily accessible funds allows individuals to cover unexpected expenses like medical emergencies, car repairs, or sudden job loss without resorting to high-interest debt or selling off long-term investments at a loss.
A liquidity trap is a contradictory situation in which interest rates are very low but savings are high. In other words, consumers and businesses are holding onto their cash even with the incentive of interest rates at or close to 0%.
On the other hand, companies with liquidity ratios that are too high might be leaving workable assets on the sideline; cash on hand could be employed to expand operations, improve equipment, etc. Take the time to review the corporate governance for each firm you analyze.
Difficult to Sell: If you hold a low-liquidity stock, selling it at the price you desire can be difficult. You may have to wait for a buyer to come along, and in many cases, that buyer will want to pay much less than the stock's current value.
Compulsory liquidation carries significant risk for directors, as when you wait for a creditor to wind up the company you can extend your creditors' losses. This may make you personally liable for the additional amounts, and you could also face accusations of misconduct that might lead to disqualification.
The current ratio (also known as working capital ratio) measures the liquidity of a company and is calculated by dividing its current assets by its current liabilities. The term current refers to short-term assets or liabilities that are consumed (assets) and paid off (liabilities) is less than one year.
Selling a business can be tricky enough, and the process is made even more complicated if the company is losing money. But is it possible to sell a business that's losing money? The short answer is yes—but there are caveats.
These four things: metrics, operational factors, pricing, and marketing strategy can hurt your profit margin more than you might imagine. Let's explore what you can do to improve on them.
Cash balance
A low cash balance, perhaps as indicated on a cash flow statement, is an indicator of a company that isn't doing well financially. Revenue could be increasing but if you just reinvest into the company, you'll find yourself cash poor.
In summary, it is absolutely possible for a company can be profitable but not liquid. This situation can arise due to several factors, such as significant investments in long-term assets, high levels of short-term debt, or a high level of inventory that cannot be sold quickly.
A good current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to covers its debts.
Extra cash may also lead to frivolous spending simply because the funds are available. If you're wondering, "How much cash should I have on hand?" it can be helpful to turn to that three- to sixth-month reserves figure. Any less and the business may be at risk of not meeting its obligations if sales were to drop.
In most cases, a car isn't a liquid asset. It may take some time to sell, you may incur costs in converting it to cash, and it probably won't sell for the same amount you put into it. In some cases, it may not sell for even the current market value, especially if you're trying to turn it into cash quickly.
Non-liquid or illiquid assets include property that is not easily liquidatable, i.e. they cannot be readily converted into cash without losing out on overall value. This means that even if these assets are converted into cash it will come at a significant loss.
Cash is the most liquid asset, followed by cash equivalents, which are things like money market accounts, certificates of deposit (CDs), or time deposits. Marketable securities, such as stocks and bonds listed on exchanges, are often very liquid and can be sold quickly via a broker.