Question

Define and compare financial flexibility to liquidity and solvency and in your opinion identify which of the three is most important to creditors. and why?

Answer 1

Financial Flexibility:Flexibility throws light on the company's ability to react to unexpected expenses that arise and investment the opportunities that come the organisation’s way..

Financial Liquidity: Liquidity is the measure of the ability of the firm to cover its immediate financial obligations.

Financial Solvency: Solvency means the ability of an organization to have sufficient assets to meet its debts as and when they fall due for payment.

Flexibility throws light on the promptness of the organization in grabbing the opportunities that come their way to the fullest and how they deal with any sudden expenditures that they encounter whereas Liquidity throws light on how quickly the assets of the organization can be converted into cash and solvency throws light on how well the organization can sustain for a long time.

Incase of Financial flexibility the risk is high whereas in case of liquidity the risk is low and in case of solvency the risk is high

Financial Flexibility focuses on how the organization reacts to the unexpected setbacks as it defines the organisation’s ability to survive the long term downturns. Liquidity focuses on the ability to pay the short term obligations whereas the solvency focuses on the capacity of the organization to meet its long term commitments.

Financial flexibility is usually assessed by examining and evaluating the company's use of leverage as well as its cash holdings whereas liquidity can be assessed by calculating the current ratio , quick ratio etc and the solvency can be assessed using the following ratios debt to equity ratio and interest coverage ratio.

Out of financial flexibility , liquidity and solvency the most important aspect or point for the creditor is the financial solvency as it states whether the organization has sufficient cash to pay for its debts as and when they become due and it also throws light on the cash and holdings that can be easily liquidated to pay up the debts. If the organization has a lower solvency ratio then it poses a huge threat or risk to the creditors as the creditors are mainly interested in knowing whether the organization is capable of paying the principal and the interest as and when it accumulates in respect of the debt.