Liquidity indicates the ease with which a business can convert assets into cash to meet short-term financial obligations. This is considered one of the important indicators reflecting the financial health and capital safety of the business. So specifically What is liquidity? and how to calculate it? Let's find out with SeABank in this article.

What is liquidity?

Liquidity is the degree to which an asset can be converted into cash quickly without changing its value. In other words, it is the ease with which an asset can be sold or converted into cash. Therefore, this factor plays an important role for credit institutions when considering a business's solvency.

Popular ways to classify assets by liquidity

In financial management, classifying assets according to liquidity helps businesses be more proactive in managing cash flow and making reasonable investment and business decisions. Below is a way to arrange asset types from high to low liquidity that businesses can refer to:

Cash: The most liquid asset, available for immediate use and continuously circulating in the economy.
Short term investment: Including stocks, securities, cryptocurrencies and other investment channels. This is the second most liquid asset group because it can be quickly converted into cash, giving investors flexibility when needed.
Accounts receivable: Short-term debts that a business is waiting to collect. The level of liquidity depends on the payment period, which can sometimes extend to several years.
Short term advance: Advances are available in many business sectors. Generally, they are easier to collect than inventories, so they are more liquid.
Inventory: The group of assets with the least liquidity, because to convert into cash it needs to go through stages such as inventory, transportation and consumption.
Other current assets: A group of assets that can be recovered or used within 12 months, such as short-term prepaid expenses, goods on consignment, or deposits.

There are different types of liquidity that businesses need to know.

Basic liquidity formula

Understanding and accurately calculating liquidity indicators helps businesses proactively control their payment capacity, promptly identify risks and build appropriate financial strategies. This is also an important factor in creating trust with investors and credit institutions.

Accordingly, there are 3 basic liquidity calculation formulas that businesses can refer to as follows:

Current Ratio

This ratio reflects the ability of a business to meet short-term debts with its current working capital. Formula:

Current Ratio = Current Assets / Current Liabilities

In there:

If the index < 1: Weak solvency, the business faces the risk of financial imbalance or bankruptcy.
If the index > 1: The business has the ability to pay its debts when due.
Current liabilities are debts payable during the year including: short-term loans, long-term loans due for payment and other payables.

Quick Ratio

This is a measure of the ability to pay short-term debts without selling inventories. Formula:

Quick Ratio = (Current Assets - Inventories) / Current Liabilities

The quick ratio shows the readiness of a business to meet its financial obligations even if its inventories have not been converted into cash.

The formula for calculating the liquidity ratio will vary depending on the type of liquidity.

Cash Ratio

The quick ratio (cash ratio) reflects the extent to which a business can immediately meet short-term debts with available cash resources. Formula:

Quick Ratio = (Cash and Cash Equivalents) / (Current Liabilities)

In which, “cash capital” includes cash, bank deposits, short-term securities and other financial assets that can be quickly converted into cash.

The meaning of liquidity for business

Liquidity represents the ability to convert assets into cash quickly at a price close to their real value. For businesses, this is a key factor to ensure the ability to pay debts when due, maintain stable cash flow and respond promptly to market fluctuations.

Cash is always the most liquid asset, allowing businesses to easily meet their financial needs. Assets such as foreign currencies, government bonds, corporate bonds or stocks also provide high flexibility in capital management.

In contrast, assets such as real estate, other fixed assets or specialized goods are often difficult to convert quickly into cash, which can affect the ability to rotate capital when needed.

Liquidity is one of the important indicators for corporate finance.

What should businesses do to ensure and improve liquidity?

Effective liquidity management is the foundation for businesses to ensure stable cash flow and timely meet financial obligations. Below are practical strategies to help businesses improve financial flexibility:

Regularly monitor liquidity ratios (e.g. current ratio, quick ratio, cash ratio).
Shorten debt collection time with clear payment policy.
Optimize and control inventory levels appropriately, avoiding "capital stagnation" for too long.
Strengthen cash flow planning and forecasting processes to proactively respond to fluctuations.
Build a cash reserve large enough to meet emergency payment needs.
Reasonable allocation between short-term and long-term assets.
Establish and maintain credit sources ready for emergency capital needs.

In addition, taking advantage of financial support solutions from reputable banks plays a particularly important role, especially for SMEs when they need capital to maintain operations, expand production or quickly seize new opportunities.

Understanding this need, SeABank has designed solution packages for SME businesses, helping to solve liquidity problems flexibly and effectively with the following advantages:

Competitive interest rates:Reduce financial burden, help businesses feel secure in using capital.
Simple procedures, quick disbursement:Save time and create conditions for businesses to be proactive in using capital.
Flexible customization:Loan packages are designed to suit the needs and characteristics of each industry and each stage of business development.

SeABank is offering many loan packages to help businesses increase liquidity.

Conclude

Clearly understanding What is liquidity? will help businesses be more proactive in financial management and make smart investment decisions. If your business wants to optimize cash flow, increase liquidity and enjoy flexible financial solutions, explore the diverse digital banking, savings and investment services at SeABank.

For more information, please contact hotline 1900 599 952 or contact the nearest Branch/Transaction Office for advice and support.