Liquidity vs Solvency

Differences Between Liquidity vs Solvency

Before making any investment, it’s essential to know two factors upfront – whether this investment will maintain the liquidity of the company and whether the investment the company is making would keep the solvency of the company intact.

Many investors overwhelm themselves with the meaning of liquidity and solvency; as a result, they use these terms interchangeably. However, these two are entirely different from each other.

And investments can affect both of these, but they are much different than each other.

Liquidity-vs-Solvency

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Liquidity vs. Solvency Infographics

As you can see that each of these concepts is much different. Here are the most significant differences between Liquidity vs. Solvency described below –

Liquidity-vs-Solvency

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Liquidity and Solvency – Key differences

As you can already see, liquidity and solvency can’t be interchanged, and they are entirely different from each other. Let’s look at the critical differences between Liquidity and Solvency –

Liquidity and Solvency Comparison Table

The basis for Comparison between Liquidity vs. SolvencyLiquiditySolvency
1.    MeaningLiquidity can be defined as the ability of the firm to pay off its current liabilities with its current assets.Solvency can be defined as the ability of the firm is to run the operations for a long period.
2.    What it’s all about?It’s a short-term concept of having enough cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation.  Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more to pay off the current debts.It’s a long-term concept of how well the operations of the firm would be run.
3.    ObligationsShort-term obligations (as expected)Long-term responsibility.
4.    Why understand this?To know how fast the current assets can be converted into cash.To know whether the firm can perpetuate, again and again, year after year.
5.    RiskPretty low.Quite high.
6.    What to look in the Balance SheetCurrent assets, current liabilities, and detailed account of every item beneath them;Shareholders’ equity, debt, long-term assets, etc.;
7.    Ratios used Current Ratio, acid test ratio, etc.;Debt to equity ratio, interest coverage ratio, etc.;
8.    Impact on each otherIf solvency is high, liquidity can be achieved within a short period.If liquidity is high, solvency may not be achieved quickly.

Conclusion

As you can see, liquidity and solvency both are important concepts for business. But they can’t be used interchangeably; because they are entirely different in their nature, scope, and purpose. Liquidity can ensure whether a firm can pay off its immediate debt. Solvency, on the other hand, handles long-term debt and a firm’s ability to perpetuate. Once you understand these concepts, you would be able to become prudent. You would also be able to make quick and effective decisions about the next move/s of your business.

Liquidity vs. Solvency Video

This article has been a guide to the top differences between Liquidity and Solvency. Here we take the differences between the two with examples, infographics, and comparative table. You may also have a look at the following articles to learn more –