Essay On Liquidity
2.1 Introduction to liquidity
According to (Averkamp, 2004), Liquidity refers to a company's ability to pay its bills from cash or from assets that can be turned into cash very quickly.
Liquid assets are those assets that can be bought and sold easily in the market. High liquidity is when an investment is easy to turn into cash (or is cash). Low liquidity is the opposite. In other words the more liquid as assets, the easier it is to sell it for a price reflecting its value.
For example, the liquidity in money is high because we can easily trade a dollar bill for four quarter or vice versa. Liquidity can be calculated using liquid ratios.
2.2 Liquidity Calculations
According to (Averkamp, 2004), “liquidity ratios analyse the ability of a company to pay off both its current liabilities as they become due as
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Liquidity also measures how easy it is for a company to raise cash or convert assets to cash in a short period. Commonly used liquidity ratios are: 2.2.1 Current Ratio
According to (Averkamp, 2004), “current ratio is the liquidity and efficiency that measures a firm's ability to pay off its short-term liabilities with its current assets. The current ratio is an important measure of liquidity because short-term liabilities are due within the next year”.
This means company has a limited time for money collection to pay off these liabilities. Current assets like marketable securities and cash equivalents can be converted into cash easily and in a short period of time.
In this case companies with larger quantity of current assets will be able to pay off their current liabilities easily as they are due, without having to sell their long term revenue generating assets.
A higher current ratio is always more favorable than a lower current ratio because it shows the company can more easily make current debt payments.
Formula to calculate current
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