Definition of Liquidity

This time we will discuss the meaning of liquidity and its functions, components and liquidity formulas. Here’s the explanation …

 

Table of contents :

What is Liquidity?

Functions and Benefits of Liquidity

Liquidity Component

Formulas for Measuring Liquidity

  1. Current Ratio
  2. Quick Ratio
  3. Cash Ratio
  4. Cash Turnover Ratio
  5. Working Capital to Total Asset Ratio

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What is Liquidity?

liquidity is the ability of a company to fulfill its obligations to pay its short-term debt (dividend payable, tax payable, etc.)

 

Another opinion says that the meaning of liquidity is the ability of a person or company to pay off debts that must be paid immediately ( current liabilities ) using current assets.

 

In general, the level of liquidity of a company is shown in certain numbers, such as; quick ratio, current ratio, and cash ratio.

 

In this case, the higher the level of liquidity of a company, the better performance is considered. To better understand what liquidity is, we can refer to the opinions of the following experts:

 

According to Syafrida Hani (2015: 121)

 

Liquidity is the ability of a company to meet all financial obligations that can be immediately disbursed or which are due.

 

According to Handono Mardiyanto (2009: 54)

 

Liquidity, namely the ability of a company to pay short-term obligations (debt) on time, including paying off long-term debts that are due in the year concerned.

 

Functions and Benefits of Liquidity

definition of liquidity

Company liquidity has its own functions and benefits for the company’s operating processes. The functions and benefits of liquidity are as follows:

 

As a medium in carrying out daily business activities.

As a tool to anticipate urgent or sudden funding needs.

To facilitate customers (for banks or financial institutions) who wish to provide loans or withdraw funds.

As a tool to trigger companies in an effort to improve performance.

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Liquidity Component

According to Robert Fry Engle and Joe Lange, in liquidity there are three basic components, namely; Density, Depth and Resistance.

 

Each of these components is interrelated to maintain the level of liquidity and economic stability in a company.

 

The following is an explanation of the three components:

 

Density: the gap or distance that occurs between the normal price of an item and the agreed price.

Depth: the quantity or volume of goods sold and purchased at a specific price level.

Resilience: the rate of change in price velocity in the direction of an efficient price even though it has gone through price deviations or volatility.

Read first:  Trading Company Financial Statements and Examples

 

Formulas for Measuring Liquidity

In general, we can measure liquidity from the ratio between current assets and current liabilities which is called the flow ratio. However, there are also companies that use other ratios as a measure of liquidity.

 

The following are some commonly used ratios for measuring liquidity:

 

  1. Current Ratio

The current ratio is the ability of a company to use current assets to pay all liabilities or current debts.

 

Current Ratio = Current Assets / Current Liabilities

 

  1. Quick Ratio

Quick Ratio is the level of a company’s ability to pay short-term debt with current assets without calculating inventory because inventory requires a long process to cash in than other assets.

 

Quick Ratio = (Current Assets – Inventory) / Current  Liabilities

 

  1. Cash Ratio

The cash ratio is the level of the company’s ability to pay short-term debt using cash, such as a checking account.

 

Cash Ratio = Cash Equivalent / Current  Liabilities

 

  1. Cash Turnover Ratio

The cash turnover ratio is the ratio that shows the relative value of net sales value to net jobs. In this case, net working capital is all components of current assets minus total current debt.

 

Cash Turnover Ratio = Net Sales / Net Working Capital

 

  1. Working Capital to Total Asset Ratio

The Ratio of Working Capital to Total Assets (WCTA) is a ratio that can assess the liquidity of total assets and the position of working capital.

 

WCTA = (Current Asset – Current Liabilities) / Total Assets

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