• Business
  • Finance
  • Banking
  • Education
  • General
  • Law
  • Science
  • IT
  • English

Key Differences

Know the Differences & Comparisons

Difference Between Liquidity and Solvency

Last updated on January 5, 2018 by Surbhi S

liquidity vs solvencyWhile liquidity is how effectively the firm is able to cover its current liabilities, through current assets. Solvency determines how well the company maintains its operation in the long run. At the time of making an investment, in any company, one of the major concerns of all the investors is to know its liquidity and solvency.

These are the two parameter which decides whether the investment will be beneficial or not. This is because these are related measures and helps the investors to carefully examine the financial health and position of the company.

For a layman, liquidity and solvency are one and the same, but there exists a fine line of difference between these two. So, take a glance at the article provided to you, to have a clear understanding of the two.

Content: Liquidity Vs Solvency

  1. Comparison Chart
  2. Definition
  3. Key Differences
  4. Conclusion

Comparison Chart

Basis for ComparisonLiquiditySolvency
MeaningLiquidity implies the measure of the ability of the firm to cover its immediate financial obligations.Solvency means the firm's ability of a business to have sufficient assets to meet its debts as they fall due for payment.
ObligationsShort termLong term
DescribesHow easily the assets can be converted into cash.How well the firm sustain itself for long time.
RatioCurrent ratio, acid test ratio, quick ratio, etc.Debt to equity ratio, interest coverage ratio, etc.
RiskLowHigh

Definition of Liquidity

We define liquidity as the firm’s ability to fulfil its obligations in the short run, normally one year. It is the near-term solvency of the firm, i.e. to pay its current liabilities.

It measures the extent to which the firm can meet their financial obligations, as they fall due for payment, with the assets like stock, cash, marketable securities, certificate of deposits, savings bonds, etc. available to them. Cash is the highly liquid asset, as it can be easily and quickly turned into any other asset.

When a firm is unable to pay off its short-term obligations, it directly affects the firm’s credibility, and if the default in the payment of debt continues, then the commercial bankruptcy occurs, due to which the chances of sickness and dissolution will be increased. Therefore, the liquidity position of the firm helps the investors to know whether their financial stake is secured or not.

Definition of Solvency

Solvency is defined as the firm’s potential to carry on business activities in the foreseeable future, so as to expand and grow. It is the measure of the company’s capability to fulfil its long-term financial obligations when they fall due for payment.

Solvency stresses on whether assets of the company are greater than its liabilities. Assets are the resources owned by the enterprise while liabilities are the obligations which are owed by the company. It is the firm’s financial soundness which can be reflected on the Balance Sheet of the firm.

Lack of solvency in the business, may become the cause for its liquidation, as its directly affects the firm’s day to day operations and thus the revenue.

Key Differences Between Liquidity and Solvency

The points given below describes the difference between liquidity and solvency in detail:

  1. Liquidity, means is to get money at the time of need, i.e. it is the company’s ability to cover its financial obligations in the short run. Solvency refers to the firm’s ability of a business to have enough assets to meet its debts as they become due for payment.
  2. Liquidity is the firm’s potential to discharge its short-term liabilities. On the other hand, solvency is the readiness of firm to clear its long-term debts.
  3. Liquidity is how easily the assets can be converted into cash. Conversely, solvency is how well the firm sustains itself for a long time.
  4. The ratios which measure firms liquidity are known as liquidity ratios, which are current ratio, acid test ratio, quick ratio, etc. As against this, the solvency of the firm is determined by solvency ratios, such as debt to equity ratio, interest coverage ratio, fixed asset to net worth ratio.
  5. Liquidity risk can affect the company’s creditworthiness. Unlike, solvency risk can lead the company to bankruptcy.

Conclusion

Both liquidity and solvency help the investors to know whether the company is capable of covering its financial obligations or not, promptly. Investors can identify the company’s liquidity and solvency position, with the help of liquidity and solvency ratios. These ratios are used in the credit analysis of the firm by creditors, suppliers and banks.

Related Differences

  • Difference Between Unqualified and Qualified Report
  • Difference Between Job Costing and Process Costing
  • Difference Between Commercial and Cooperative Banks
  • Difference Between Less and Fewer
  • Difference between CBSE and ICSE Board

You Might Also Like:

asset-vs-liability-thumbnailDifference Between Assets and Liabilities Difference Between CRR and SLR Business Risk vs Financial RiskDifference Between Business Risk and Financial Risk Capital Structure Vs financial structureDifference Between Capital Structure and Financial Structure Book Value Vs Market ValueDifference Between Book Value and Market Value fdi vs fpiDifference Between FDI and FPI

Comments

  1. ADEBIYI, Oluseye akano. says

    December 15, 2017 at 9:47 pm

    This is a detailed presentation and has been so useful to me. Thanks a lot.

    Reply

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Top 5 Differences

  • Difference Between PERT and CPM
  • Difference Between Micro and Macro Economics
  • Difference Between Developed Countries and Developing Countries
  • Difference Between Management and Administration
  • Difference Between Qualitative and Quantitative Research

Related Differences

  • Difference Between Unqualified and Qualified Report
  • Difference Between Job Costing and Process Costing
  • Difference Between Commercial and Cooperative Banks
  • Difference Between Less and Fewer
  • Difference between CBSE and ICSE Board



New Additions

  • Difference Between Speak and Talk
  • Difference Between Economy Class and Business Class
  • Difference Between If and Whether
  • Difference Between Hotel and Motel
  • Difference Between FIR and Chargesheet
  • Difference Between Norms and Values
  • Difference Between Society and Community
  • Difference Between Sourcing and Procurement
  • Difference Between National Income and Per Capita Income
  • Difference Between Departmental Store and Multiple Shops
fb-follow youtube follow

Copyright © 2023 · Key Differences · Contact Us · About Us · Privacy