Liquidity.

Liquidity - Money Matters.

This post is about liquidity. We all need money everyday and for every purpose. If money is available easily, then liquidity is said to be present. If it is not, then liquidity is poor. Liquidity needs may arise anytime, but mostly it is seen during emergencies. The need for money never stops and there has to be some ways to meet liquidity requirements.

Meaning of Liquidity.

Liquidity means the availability of money or some other sources of money which could be used for meeting expenses of some kind. Liquidity generally refers to cash which is available or which could be made available quickly when its need arises. Liquidity denotes the ease and the quickness with which funds will be available for use. The word 'fund' is used to suggest lots of money with which a high value purchase or investment could be made or an emergency could be tackled and liquidity is usually used in this context.

Liquids can flow and so can money. Money can flow like water, which is a universal liquid. This could probably be the reason why the term liquidity began to be used to suggest utilizable money or readily available cash. How good it would be if money flows into our hands as quickly as water flows out from an open tap!

Importance of Liquidity.

The urgent need for money for some specific purpose other than the usual expenses makes liquidity dearly important. There are times when funds are needed urgently. In a situation where we cannot wait in anticipation of getting money, that we realize how important liquidity is.

Savings and Liquidity.

Adequate savings can meet immediate demand for money. Savings is the first option which people search for whenever the need for money arises. Good balance in bank helps reduce liquidity problems to some extent. However, utilizing savings too much is not advisable if other options for money are available.

Some people build up savings only for liquidation. In fact, some people use their savings for liquidity purpose even when other options are available for them. For instance, if a person, who has Rs. 8.35 Lakhs balance in bank wants to buy a car which costs Rs. 6.75 Lakhs, will it be advisable to liquidate his account if other options are available for him?

The appropriate suggestion would be 'No'. This is because, spending 6.75 Lakhs from a balance of Rs. 8.35 Lakhs will reduce savings drastically. Other options, like a bank loan, if available, should be considered first before spending from account.

Traditional Liquidity Options.

Traditionally, the requirements for liquidity were met through borrowing and selling assets. Later, organised lending became popular and began to be used extensively. By and large, people have been relying on three options for liquidity. As these were in use for quite some time, we can consider them as traditional liquidity options.

The three liquidity options are:

(1) By borrowing from people we know: Borrowing money from relatives and friends is an option, when the requirement is not too much. This is an ancient practice. It is probably the most easy and hurdle free way for people to get money. Mutual trust is the foundation for borrowing. When people borrow money from somebody who is capable of lending, there is an unspoken agreement of minds based on trust.

(2) Selling assets: Selling assets altogether is another way to meet liquidity needs. Assets have value and so could be liquidated. Some assets, like gold, could be sold quickly. Gold when sold fetches good amount of money.

(3) A loan: Loan is an option which is good to avail if the money needed is more than, say ten times of monthly income. A loan can meet personal and business liquidity needs.

Shortcomings of Traditional Methods.

Although traditional methods are proven and are useful, they aren't practical all the time and for all purposes. For instance, funds may not be available for frequent needs. It may be costly too.

The shortcomings of the three traditional methods are:

(1) Borrowing: Borrowing is good, but it has shortcomings. When we say borrowing, we specifically mean borrowing from people who are capable of lending money and not from organisations like banks or financial institutions. The lender could be relatives or friends, colleagues or people whom we know. Borrowing from people is not practical every time, because individuals are not financial institutions. We may not get the money which is actually needed.

(2) Selling assets: Although Selling assets could fulfill the requirements of liquidity to some extent, it is not always profitable. Assets like an automobile is hard to sell and may not fetch a fair price.

(3) Loan(s): Loans too have some limitations. Loans are provided by banks and financial institutions only to them who are eligible for it. Many a times, the eligibility criteria becomes the hurdle in getting loans. This option has some drawbacks and may not be feasible for all purposes, particularly when there is recurring liquidity requirements.

Liquidity Problems.

Liquidity is an issue for many people. The problem of liquidity affects everybody at some stages in life. Even rich people may face liquidity issues. When funds are not available for an upcoming event or requirement, it indicates liquidity problems. Liquidity issues may arise in every occupation and people engaged in jobs or businesses or professions may have to face such situations at some point.

• People in jobs have to face the crunch quite often if their salary does not help savings to get build up to a reasonable level every month.

• Professionals who earn fees and commissions have a similar story. Fees and commissions are not static by nature. They vary. Some months may be more favourable for earning and some not. When earnings fluctuate too much towards the negative side, the savings get affected. Professionals, no matter how capable and efficient they are, have fluctuating income.

• People in business too have hard times. When business faces difficulties in supporting itself, some financial assistance may be required to put it on track. The businessman will have to arrange funds from somewhere and this is where the challenge is: where will he get the funds from and what will be the cost of funds?

Getting funds is not an easy task. Funds are costly. The cost of funds should be bearable, otherwise, it could prove counterproductive. When we seek money from a financial institution and get it, we are actually purchasing funds. We buy money for an interest which has to be paid.

What triggers liquidity issues?

Liquidity issues arise due to poor financial condition. Poor financial condition may be due to poor planning. When people earn, spend and save without proper planning, their financial setup may not remain stable to handle huge and urgent demands of money.

Issues with liquidity may arise due to the following reasons:

(1) Inconsistent income: When income is inconsistent, the chances for liquidity issues are more. Income which is not regular, or isn't adequate enough creates problems for savings and liquidity.

(2) Blocked income: When income gets blocked due to any reasons, liquidity gets affected. Blocked income could be receivables of any kind.

(3) Too little savings: Too little savings is one of the reasons why liquidity issues arise. Liquidity is difficult if savings are less.

(4) Over investment: Over investment is also a reason for liquidity issues. Money blocked in investments cannot be easily liquidated.

(5) Over expenditure: Excessive expenditure certainly makes liquidity difficult. Funds deplete soon when expenses are more.

(6) Too much loans: Taking too many and too much loans or credit can create problems for liquidity.

(7) Too much lending: Lending too much money has the same negative effect on availability of cash.

Managing Liquidity.

Liquidity management is very important for regular functioning of business as well as for meeting personal needs of an individual. Liquidity management is a process which involves three important aspects: income, savings and expenditure. These three aspects, if managed properly can overcome most difficulties of procuring funds.

Increasing income, increasing savings and reducing expenditures are important for financial health. If these three things are in order, then liquidity, as an issue, may not arise. However, for most people, increasing income is not an easy proposition and many people struggle in this.

If income is low, savings will be low as well. Any shortfall in income and savings will have negative effect on the financial setup and it will affect liquidity badly. As expenditures require money which comes from income and savings, people who are poor suffer a lot. Managing liquidity is therefore important.

Some suggestions for liquidity management are:

(1) Save as much as you can: Savings form the foundation for all needs of money. It may seem difficult initially to start saving, but it is not impossible. Some money has to be saved regularly to make provisions for funds.

(2) Limit expenditures: Limiting expenditures, particularly those which can be avoided, helps in saving. Heavy expenditures require liquidity. Avoid liquidating for avoidable purposes.

(3) Invest wisely: Investments are needed, but it should be done wisely. Do not put money in high risk avenues without assessing the risks.

(4) Ensure regular income: Regular income is a must for survival. Ensuring regular income is as important as anything else.

(5) Avoid too much borrowing or taking loans: Borrowing too much or taking heavy loans could upset financial decorum and increase the burden of debt. Liquidity may not be possible if the debt is huge.

Liquidity has been and will always be a topic for discussion everywhere. It is the cash in hand. It is the cash in bank. Everybody needs it every time, because, like blood in a living body, it nourishes everybody financially.

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