What is liquidity in accounts

liquidity

Liquidity is one financial key figure from the field of business administration (BWL). It is often used in the Controlling used to see if companies are still solvent. For banks, the processing of liquidity indicators is part of the Balance sheet analysis extremely important as these can reveal a lack of liquidity. However, the controller does not like too much liquidity in the company, as this is too Loss of profitability can lead. Credit institutions therefore use the qualitative company analysis to check whether the respective company still has free liquidity reserves or free credit lines. There are several metrics used to measure a company's liquidity. The Degrees of liquidity are the best known calculation.

liquiditycalculation
1st degree:Liquid funds / short-term liabilities (debt)
This calculation shows the extent to which a company can cover its short-term liabilities with its cash and cash equivalents alone.
2nd degree:Cash and cash equivalents and short-term receivables / short-term liabilities
3rd degree:Current assets / short-term liabilities

The importance of liquidity has affected the banking industry particularly since the 2008 financial crisis. The ECB has therefore tried to prevent the banks from doing so Illiquidity to protect. This undertaking was implemented with the regulations passed in Basel III. This resulted in the introduction of new key figures as minimum requirements for maintaining liquidity, which should avoid a lack of liquidity at banks.

liquidity represents an investment criterion and forms together with profitability and security the “Magic Triangle of Investment”. When it comes to liquidity, two questions come to the fore. How quickly can the investor turn his investment back into capital? And what are the costs involved?

How quickly is the money available?

Unemployment, divorce or illness - different scenarios and payment obligations can lead to a change in the income situation and the income is no longer sufficient to cover all costs. Unexpected expenses such as the care costs for a dependent relative can also lead to a temporary liquidity gap. In this situation, it is important to avoid illiquidity and to have quick access to your financial reserves in order to avoid insolvency.

The different Investments differ in the level of liquidity they offer. Acquired real estate, for example, is extremely unfavorable in terms of liquidating it as quickly as possible. Selling a house or a condominium is relatively expensive. Even if business goes off without a hitch, allow at least three months for the money to change hands. Investment forms such as simple savings or equity holdings therefore offer the highest level of quick liquidity. The reserves can usually be converted into cash within a day.

How much does it cost to liquidate fixed assets?

Liquidity is directly related to the profitability, another factor in the Magic triangle of investment. As a rule, the higher the liquidity of an investment, the lower the return. A call money account, for example, contains a lot for the saver flexibility, but usually yields the lowest interest. But liquidity can also have a negative impact on the profitability of long-term investments. This is the case if the early liquidation entails additional costs or investment losses.

A typical example is life insurance. Anyone who closes this system in the first few years after taking out the contract can lose up to 50 percent of the insurance premiums paid. At this point, the majority of the deposits are still used to cover insurance fees and the insurance agent's commission.

Reduce risk through liquid reserves

In order to avoid the liquidity problem with an investment, two investment strategies have been established with regard to liquidity planning: * Build up a financial buffer for short-term liquidity * Spread the savings over investments with different liquidity

As soon as an investor has clarified for himself how much money he has to pay monthly minus fixed costs and living costs Investment can use, it makes sense to build up a financial cushion. These are immediately available investments that are in a savings book or an interest-bearing account. The need for the level of liquidity varies from person to person. Many experts recommend reserves that match normal earnings for 3 to 6 months. This can be used to compensate for many temporary bottlenecks. In addition, you gain time, for example to turn hard-to-sell fixed assets into cash.

Spread fixed assets

The financial buffer is only sufficient to bridge short-term bottlenecks. To be more permanent Solvency To guarantee, access to the actual fixed assets is essential. However, if the investment portfolio only consists of rather illiquid assets such as closed fund investments or life insurance, the investor has a problem. That is why one of the principles of investment is to use savings capital if possible to be distributed across different types of investment with different levels of liquidity. This means that long-term investments with high profitability are more likely to be protected and short-term liquidity is still guaranteed.

Reallocate fixed assets

For the division of the property into liquid and illiquid assets Incidentally, there is another argument. The capital markets are constantly changing. There is simply no telling how the overall economic situation will develop in ten or twenty years. The Central banks' low interest rate policy has a direct impact on the return on traditional savings deposits, for example. Liquid assets have the advantage that the investor can react to changing conditions at any time and, if necessary, switch capital into investments with more lucrative returns.

Special case real estate

Real estate, like life insurance or a closed fund, is one of the more illiquid investments. However, this form of investment still offers some notable advantages in terms of liquidity. Selling takes time. But the increase in value can be considerable after ten or twenty years, so that an early sale may not have as serious an impact on the profitability as with a life insurance. On the other hand, a mortgage can be taken out on a property at any time in order to ensure liquidity. The loan is of course associated with costs. A comparison between the mortgage rate and the normal loan rate shows which loan is the more sensible alternative. In any case, the advantage of real estate is that, depending on its value, it can sometimes meet high liquidity requirements.