Can liquidity be too high?
Yes, a company with a liquidity ratio of 8.5 will be able to confidently pay its short-term bills, but investors may deem such a ratio excessive. An abnormally high ratio means the company holds a large amount of liquid assets.
It can also lead to economic instability, as people may lose confidence in the markets and stop spending money. Too much liquidity can also lead to inflation. This happens when there is more money chasing after goods and services than there are goods and services available.
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.
Strong liquidity means there's enough cash to pay off any debts that may arise. If a business has low liquidity, however, it doesn't have sufficient money or easily liquefiable assets to pay those debts and may have to take on further debt, such as a loan, to cover them.
An abnormally high ratio means the company holds a large amount of liquid assets. For example, if a company's cash ratio was 8.5, investors and analysts may consider that too high. The company holds too much cash on hand, which isn't earning anything more than the interest the bank offers to hold their cash.
Typically, high liquidity risk indicates that particular security cannot be readily bought or sold in the share market. This is because an issuing company might face challenges in meeting its current liabilities due to reduced cash flow.
A company's liquidity indicates its ability to pay debt obligations, or current liabilities, without having to raise external capital or take out loans. High liquidity means that a company can easily meet its short-term debts while low liquidity implies the opposite and that a company could imminently face bankruptcy.
High-risk investments typically offer lower levels of liquidity than mainstream investments, so, particularly if something's gone wrong and performance hasn't met expectations, getting access to your money when you want may not be as easy.
Disadvantages of financial liquidity
While liquidity is important, there are several downsides to keeping a surplus of cash assets including: Lower interest rates. Loss of buying power over time as returns trail inflation. Potential for inflation.
As long as a firm holds too much cash, and a is sufficiently large, the firm tends to over invest in riskier assets, generating instability.
What causes high liquidity?
High levels of liquidity arise when there is a significant level of trading activity and when there is both high supply and demand for an asset, as it is easier to find a buyer or seller.
Understanding Liquidity Ratios
A low liquidity ratio could signal a company is suffering from financial trouble. However, a very high liquidity ratio may be an indication that the company is too focused on liquidity to the detriment of efficiently utilizing capital to grow and expand its business.
In general, a higher liquidity ratio shows a company is more liquid and has better coverage of outstanding debts. Alternatively, external analysis involves comparing the liquidity ratios of one company to another or an entire industry.
High liquidity means that an asset can be easily converted to cash for the expected value or market price. Low liquidity means that markets have few opportunities to buy and sell, and assets become difficult to trade.
Liquidity is a company's ability to convert assets to cash or acquire cash—through a loan or money in the bank—to pay its short-term obligations or liabilities.
Liquid markets such as forex tend to move in smaller increments because their high liquidity results in lower volatility. More traders trading at the same time usually results in the price making small movements up and down. However, drastic and sudden movements are also possible in the forex market.
Excess liquidity has a negative relationship with bank stability.
In this section we identify and define three main types of liquidity pertaining to the liquidity analysis of the financial system and their respective risks. The three main types are central bank liquidity, market liquidity and funding liquidity.
Certainly, for institutional investors holding large quantities, the prized liquidity can also turn into a vicious trap where selling in response to prices falling, leads to an acceleration of this trend as everyone rushes for the exit at the same time.
A liquidity crisis occurs when a company can no longer finance its current liabilities from its available cash. For example, it is no longer able to pay its bills on time and therefore defaults on payments. In order to avoid insolvency, it must be able to obtain cash as quickly as possible in such a case.
What leads to higher liquidity and higher profitability?
Working capital affects both the liquidity as well as the profitability of a business. As the amount of working capital increases the liquidity of the business increases.
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.
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. A current ratio below 1 means that the company doesn't have enough liquid assets to cover its short-term liabilities.
| S.No. | Name | CMP Rs. |
|---|---|---|
| 1. | NMDC | 240.90 |
| 2. | Bharat Electron | 234.45 |
| 3. | Vedanta | 370.55 |
| 4. | NBCC | 125.95 |
A distinction can be made between: (i) asset liquidity; (ii) an asset's market liquidity; (iii) a financial market's liquidity; and (iv) the liquidity of a financial institution. An asset is liquid if it can easily be converted into legal tender, which per definition is fully liquid.
