Q:

What is the difference between solvency and liquidity?

A:

Liquidity is the ability of a company or country to meet its near-term cash flow requirements. Solvency is the ability for a company or country to meet its long-term financial obligations.

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Assets are what a company can use to pay for goods and services. Assets may be cash, inventory, property or other financial instruments. Companies use assets to pay for its liabilities.

When a company’s assets are greater than its liabilities it is solvent. In other words, if all of its liabilities were due immediately, it would have enough assets to pay them off.

However, a liquidity issue arises if a company does not have enough cash to pay for its immediate debts. A company that is solvent can typically acquire cash to resolve this liquidity issue by getting a loan against assets or issuing stock.

A company can have liquidity and be insolvent. This occurs if a company has enough cash to meet its near-term debts, but all of its assets are less than the total amount of money owed. A company can sometimes resolve insolvency, particularly if it has liquidity. To do so the company reduces expenses to increase cash flow to eventually have more assets than debts, or the company reduces debts, which may include negotiating with the debt holders to reduce the total amount owed.

Countries are more complex, especially as many can print their own money to address liquidity issues.

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