Question

1. Liquidity: What does liquidity measure? Explain the trade-off a firm faces between high liquidity and low liquidity levels. Think about the type of business industry you would like to enter, the form of business organization you would prefer to be a part of (sole proprietorship, partnership, or corporation), and relate that information to the concept of liquidity: think about the ease or difficulty involved in raising funds for your prospective business!

write about 350 words.

Answer 1

Liquidity measure ability of a firm to convert its asset in cash or cash equivalent without any significant loss in the value. It is understandable that if a firm is able to conver its asset in cash, it is a liquid asset. However, if you focus on the other underlined line i.e. without any significant loss in the value, it is very important in terms of understanding liquidity measure and liquid asset.

For example, Suppose you have a building. Now building is not a liquid asset. However, if today the value of building is $50 million but for the sake of selling you reduce the price of the building and sell it for $40 million i.e. less than its value. You are selling it now i.e. you are able to convert asset in cash. However, it is not consider as liquid asset because there is a signifcant loss in the value of the asset and that is $10 million. Therefore, your liquidity measure is reduced.

Firms that have higher liquid measure are at safer side because they can meet short-term credit or demands. However, liquidity also has an opportunity cost. In a manner, if you are investing in a long term asset, there are higher return. Investing in long term will reduce your liquidity as long term asset are not sold quickly. But you get hefty return on long term investment. It depends on financial manangers and type on industry that defines the liquidity measure.

Sole Proprietorship

A sole proprietorship firm is a firm where there is a single owner. Even the liabilities are unlimited. Therefore capital raising is tough as a single person cannot raise huge amounts of money. Also, if he raises huge amount of money, due to unlimited liabiliy the owner's personal assets are trapped in case of defaults of huge amount. Therefore, raising money in case of sole prorietorship is tough and the capital is limited.

Partnership

A partnership is an organisation which as two or more members as its manager. Since, there are few more people in a partnership than sole firm, the money raising is easy. However, there is a limitation of unlimited liability and with this limitation it becomes difficult to raise money in partnership aswell.

Corporation

A corporation is firm that has no shareholders as its owner and shareholders have no limit. There can be many shareholders. The money with the shareholders is huge and therefore capital raising becomes easy as when these money is pooled, the amount becomes huge. Also, the liability of a shareholder is limited to the extent the share he hold in the organisation and therefore, there are no risks on the personal asset of the shareholder. This make capital raising easy. Also, there is defined board of directors and managers that governs activities of corporation which lures institutional investors to invest in the organisation. Therefore, capital raising is easy.

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