Factors Of Liquidity
Liquidity, a significant measurement of success of any business, is indicative of the fact that the business has sound accounting processes and a good control over its internal cash flows. It is also a vital tool for the business’ stakeholders, including the banks and the investors, to evaluate the business operations. |
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However, the recent sub-prime mortgage crisis and the consequent economic slump have necessitated the benchmarking of some of the most vital liquidity factors, described as follows:
- Monetary Liquidity Factors: The most significant factors of liquidity or the basic supply of money in any business include Fed Credit and Monetary Base. These two composites are tightly controlled to enable increasing the short-term rates and to sustain the present market structure. Last year, while Fed Credit was augmented by 3.7 percent, Monetary Base was increased by only 2.2 percent.
- Credit-Driven Liquidity Factors: The recent economic slump in C and I sectors have led to a significant reduction in working capital needs of businesses. This in turn has further flattened the demand for C&I loans. In such a scenario, credit-driven liquidity tends to slow down, compelling Fed to enhance monetary liquidity into the prevailing system. This can certainly be very risky!
- Economic Liquidity Factors: As the supply of money in market exceeds the total production costs, additional liquidity gets generated, thereby fueling positive financial market speculations. However, these liquidity factors are highly dynamic and must be monitored regularly.
- Trade-Driven Liquidity Factors: These factors serve as useful measures to evaluate the gross outflow of dollars from U.S. owing to trade deficit. Any rise in dollar outflow causes liquidity to increase in international market. The opposite of this is also true.
Thus, liquidity depends on a number of factors. While calculating cash liquidity using numerous accounting functions, the various factors that are indicative of liquidity issues include Accounts Receivables, Accounts Payables, and the current liabilities or short-term debts.
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