Question

what is liquidity risk and factors that influence it?

Answer 1

Liquidity risk is the risk that financial corporations are not able to meet their short term obligations as and when it is due. The business might have problems converting the asset into cash due to the lack of available buyers or due to an inefficient market due to which it faces the problems of meeting it's financial obligations

The factors that influence liquidity risk is :

• Drag on liquidity : when the inflows of the business is dragged or delayed then it is a drag on liquidity.

Examples of drag on liquidity is bad debts, expensive trade credit form suppliers.

• Pull on liquidity : when the outflows of cash increases it is a pull on liquidity.

Examples of pull on liquidity is making faster payments to suppliers, the liquidity conditions of the market are poor.

• Uncertain cash flow projection the uncertainty regarding the inflows and outflows of cash is a major factor affecting the liquidity of any firm. We can predict with 100% accuracy that accounts receivables will be collected within the stipulated time say within a period of 45 days.
• The polices set by the management: If the management of the company is risk averse, then they will maintain sufficient cash balance. If the management prefers high return over security then instead of keeping adequate cash balance they invests in high risky securities.