Company liquidity: how it differs from solvency

Liquidity is about timing; solvency is about the bottom line. Liquidity shows whether a company has enough cash, and enough assets that can be turned into cash quickly, to cover the payments of the coming months: wages, taxes, a coupon, the repayment of a short-term loan. Solvency shows whether all of its assets cover all of its liabilities in general, taking into account long-term debt and accumulated equity. These are different questions addressed to different parts of the financial statements, and the answers diverge more often than it seems: a profitable company with solid equity is capable of missing a payment date, while a company whose equity has been eaten away is capable of paying punctually for years, for as long as it keeps being refinanced.

What exactly liquidity measures

Liquidity is the property of a particular asset to turn into cash without a loss in price and without a long wait. Cash in the account is liquid by definition; a short-term deposit and marketable bonds are near-cash; receivables become cash when the buyer pays, not when the seller needs it; inventory in the warehouse may never become cash at all, or may do so only at a discount. A company's liquidity is the same logic assembled across the balance sheet: how well the structure of current assets matches the schedule of obligations.

This is where the mechanism of the gap comes from. A company can be rich and still have nothing to pay with on Friday, because the wealth is locked up in work in progress, in a warehouse of seasonal goods, in the cash of a subsidiary or in an asset that takes months to sell. This is a cash gap: not a loss, but a mismatch of timing.

Solvency: a different horizon and a different lens

Solvency looks at all of the debt and all of the equity. The tools here are net debt to operating profit, interest coverage by operating cash flow, and the share of equity. Negative equity is a signal of insolvency regardless of how much cash is in the accounts today: liabilities exceed assets, and they can be settled only by taking on new liabilities.

The reverse asymmetry occurs as well. A company with a comfortable debt load enters a year in which a large issue comes due while the capital market is closed to it, and the problem turns out to lie not in the debt as such but in the calendar. That is why liquidity is read together with the repayment schedule, not separately from it.

Combinations found in practice

Solvent and liquid is the normal state. Solvent but illiquid is a cash gap, which is cured with a credit line, the sale of an asset or a deferral; this is exactly where growing companies that have put their cash into working capital end up. Liquid but insolvent is a dangerous state: there is cash because it was raised recently, while equity is already negative. Neither the first nor the second is the road to restructuring or bankruptcy.

The ratios and how they mislead

The current, quick and cash ratios differ in what they strip out of current assets: first inventory, then receivables, leaving only cash. They are useful not in themselves but in comparison: with earlier periods of the same company and with its own industry. A retail chain routinely lives with negative working capital, while in machine building the norm is different, so a cross-industry comparison on these ratios is meaningless. The order in which it makes sense to arrange such checks is covered separately: how to compare companies.

The main trap is the date. A ratio is calculated as of the reporting date, and that date is easy to dress up: hold back payments to suppliers, speed up the collection of receivables, take out a short-term loan. The ratio does not see the quality of the numerator: overdue receivables from a single large debtor and diversified receivables look the same on the balance sheet.

A company's liquidity and the liquidity of its security are not relatives

The word is the same; the subjects are different. Market liquidity is about whether a security can be sold quickly and close to the last price; it is a property of trading, not of the balance sheet. A company that is strong on its financial statements may be thinly traded, and then an illiquidity discount is applied to its valuation. And the other way round: an actively traded security with a high multiple — 3,71 for {{instrument:SBER}}, as an example of an indicator that says nothing about payment discipline — does not report on what the company will use to cover its next coupon. Why market valuation and internal condition diverge is examined in the piece on price and value, and how market liquidity vanishes at the moment it is needed most is examined in the piece "Liquidity: why it is noticed only when it runs out".

What to look at for a Russian issuer

Start with the financial statements: cash and equivalents, the structure of current assets, short-term debt, operating cash flow. Then check the schedule of events: the corporate events calendar shows the dates to which payments are tied. Check dividends against the payout calendar: {{dividend_calendar|limit=5}} — a payout comes out of cash, not out of profit, and a generous policy combined with thin liquidity means that the company is financing it with debt. A separate layer is infrastructure restrictions: a blocked account or an inaccessible settlement channel turns a sound company into a non-paying one, and this risk is built differently from market risk (sanctions and the market).

What these data will not show

The platform's data give reported values with a lag and within the limits in which the company discloses. From a published balance sheet it is impossible to see in which settlement channel the cash sits and whether it is available to the parent structure, what part of receivables is overdue, which covenants are written into the agreements and whether there are undisclosed guarantees on the debt of related parties. This is not a reason to ignore the ratios; it is a reason not to take them for a verdict. The definitions used here are collected in the glossary.