Liquidity vs Solvency

Difference between Liquidity vs Solvency

Liquidity refers to the firm’s ability to meet its short-term financial obligations or how quickly a firm can convert its current assets into cash. Assets such as inventory, receivables, equipment, vehicles and real estate aren’t considered liquid as they can take many months to convert to cash. Solvency refers to the firm’s ability to meet its long-term financial obligations. One of the primary objectives of any business is to have enough assets to cover its liabilities. This is known as solvency. Along with liquidity, solvency enables businesses to continue operating.

Head To Head Comparison Between Liquidity vs Solvency (Infographics)

Below is the top 8 difference between Liquidity and Solvency

Key differences between Liquidity vs Solvency

We may note, before making the investment the relevant factors that need to be looked upon is – liquidity vs solvency, as these are related measures and helps the investors to carefully examine the financial health and position of the company. Both Liquidity vs Solvency are popular choices in the market. let us discuss some of the major Difference Between Liquidity and Solvency:

Liquidity refers to the firm’s ability to meet its current liabilities with the help of its current assets. On the other hand, solvency refers to the firm’s ability to meet its long-term debt obligations.
Liquidity can be calculated by using ratios like current ratio, cash ratio, quick ratio/acid test ratio etc. Solvency can be calculated using ratios like debt-to-equity ratio, interest coverage ratio, debt-to-asset ratio etc.
Liquidity is the short term concept as it relates more to short-term cash flow. On the other hand, solvency is the long terms concept, which relates more to long terms financial stability of the firm.
Better solvency ratios indicate a more creditworthy and financially sound company in the long-term. On the other hand, liquidity ratios indicate how easy it will be for the company to raise enough cash or convert assets into cash.
Liquidity helps to determine the current picture about the firm’s performance but solvency can determine whether the firm will remain solvent or not.
A bad Liquidity vs solvency position should be a warning sigh to the investors, as it suggests that the company might be facing trouble to meet its short-term obligations and is struggling to fund its long-term obligations.
A solvent company is one that owns more than it owes; in other words, it has a positive net worth and a manageable debt load. On the other hand, a company with adequate liquidity may have enough cash available to pay off its current bills.
If a company finds that it has unexpected expenses but has high liquidity, it can easily sell some of its cash assets to pay for those expenses without facing any financial challenges. On the other hand, a company must have lower debts to ensure that they are able to reinvest in their business to expand operations, as higher debts require to pay high-interest payments which will eventually erode all the profits and firm will not remain solvent.