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Sources of and drag and pull on liquidity

Liquidity refers to the ability of a company to satisfy its short-term obligations using assets that can be readily converted to cash. Liquidity depends on both the type of asset and the speed at which it can be converted to cash.

Liquidity management refers to how a company balances its short-term liabilities with short-term assets. Even though long-term assets may also be converted to cash to improve liquidity, it has other costs for a company, for example, it may impair a company’s financial strength.

Primary vs secondary sources of liquidity

Primary sources of cash include ready cash balances, short-term funds (such as trade credit, bank lines of credit, etc.), and cash flow management (i.e. the level of decentralization, because decentralized cash management means more cash will be tied up).

Secondary sources of liquidity differ from the primary sources in that using a primary source does not affect normal operations of a company but using a secondary source does. Secondary sources include renegotiation of debt contracts (to switch to low-interest loans), liquidating assets (selling them), and filling for bankruptcy.

Drag and pull on liquidity

A drag on liquidity refers to delay in receipts while a pull on liquidity refers to an acceleration in disbursements.

Drags include uncollected receivables (which may be bad debts), obsolete inventory, tight credit (which makes short-term credit more expensive). Drags may be alleviated by stricter enforcement of credit.

Pulls include early payments to vendors, reduced credit limits, limits on short-term lines of credit, and low liquidity positions (due to the company’s industry).

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