Lesson 4 of 7 · All lessons in this module
- The operating cycle and the cash conversion cycleVideo lesson
- Shortening the cycle and the cost of trade creditVideo lesson
- Total and net working capital
- Liquidity and its primary and secondary sources
- Drags, pulls and liquidity ratiosVideo lesson
- Conservative, moderate and aggressive working capitalVideo lesson
- Short-term funding strategy
Lesson 4 of 7 · 13 min
Liquidity and its primary and secondary sources
An issuer is liquid when it can meet its short-term obligations; it draws first on cash, borrowing and operating cash flow, and turns to costly secondary sources only under stress.
In short
- An asset's or liability's liquidity is its nearness to cash or settlement. Cash is the most liquid asset; inventory is among the least liquid current assets.
- An issuer's liquidity is its ability to meet short-term liabilities, set by the amount and liquidity of its short-term assets and liabilities, which in turn depend on its business model.
- Primary sources: cash and marketable securities, borrowing (banks, bondholders, trade credit) and cash flow from the business, the main long-run source.
- Free cash flow = cash flow from operations − investment in long-term assets.
- Secondary sources: cutting dividends, delaying capital spending, issuing equity, renegotiating contracts, selling assets, bankruptcy protection. Using them usually signals deteriorating health and carries liquidation costs.
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