Question

1). What is the difference between Liquidity and Solvency of a firm?

2). Are they equally important or does one trump the other when it comes to relative importance?

3). Can a solvent company go bankrupt owing to unexpected liquidity problems? If so please explain with example(s)?

Answer 1

I have answered first two questions. Please get back to if you need any clarifications. Hope this helps!

1) Liquidity and solvency sounds similar and there is subtle difference between both of them.

Liquidity is more of short term oriented and refers to cash mostly. It emphasizes on whether the company be able to fulfill its short term or current obligations or immediate needs. It also means the ability of the company to convert its current assets into cash to fulfill its current obligations. Liquidity is very important for day to day operations of the country

Solvency is more of medium or long term oriented and it refers to non-cash assets. It emphasizes on whether the company be able to repay its long term debt or other long term obligations in the future. It also emphasizes on the sustainability and perpetuity (on going) of the business by able to conduct its operations in the long term

2)

They are equally important, as they both speak about different contexts of business (short term and long term). They also impact one another. Fulfilling only liquidity but not solvency may help the to survive in the short term but does not make the business to perpetuate. On the other hand, fulfilling only solvency does not help, as liquidity crunch leads to bankruptcy