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Liquidity Risk | Examples | Measurement of Liquidity Risk - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell ican friends today we
learn a topic that is called liquidity
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risk now what exactly is the liquidity
risk see this is the very important
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component for every business I mean in
every business I'm talking about
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liquidity risk is going to be there so
the term liquidity risk means cash
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current situation and that can come at
any time it's its uninvited guest for a
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temporary or a short time period and
usually it happens during the the
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unseasonal period this kind of situation
are generally having an adverse effect
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on any business and the profit-making
organization because I'll give an
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example in 2008 when the mortgage
meltdown happen a very healthy company
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like General Electric and they were
facing a cash crunch they makes engines
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light bulbs but why they have faced an
amount of risk of liquidity and due to
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which they had to call upon the Treasury
secretary that if the business doesn't
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improve on us then the prisoners are
shutting down so why this kind of thing
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let's understand what exactly is
liquidity risk the definition that's the
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first thing that we are going to learn
now the term liquidity risk means the
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cash crunch situations for a very
temporary or a short time period and
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this kind of situations are generally
having a turmoil effect on any business
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and profit making organization so unable
to meet short-term debt or long-term
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liabilities the business house ends up
with negative working capital right in
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most of the cases so this is familiar
situation which is cyclically nature in
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happens during the recession or when a
particular economy is not doing well on
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the other hand if the company has an
obligation to pay its short-term
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expenses payments to its creditors or
short-term loans on a monthly basis
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let's take an example of the liquidity
risk I'll give you some of the examples
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so that you may have an idea the first
example I can give you as the inability
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to meet the let's say the short-term
debt due to the exceptional losses or
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you can see the damages during the
operations second when they are unable
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to
the proper funding okay with specific
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time frame in most of the startup
companies this usually happens the
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startup funding be is the accompanies
there is a risk of breakeven so if the
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business does not get the next funding
then there can be a possibility of
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liquidity risk now the third in the most
important the rise of the material
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causes arises in the manufacturing
expenses for the concern so for example
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liquidity risks can arise in the
commodity prices is not welcomed for the
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business which in manufacturing like
auto ancillaries so for example
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liquidated risk if we analyze the
financial ratios of ABC engineering
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company we would find the following
let's say the revenue grew around a
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12.17% now in financial 18 versus 17 now this is
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not for ABC this is Suprajit
engineering company and this are the
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data for the same the material cost okay
it had bumped up close enough to
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16.06% and the gross
profit had was 45.74%
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versus a 45.
sorry 47.56 %
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year go so this was the case
with them now because of the rise in the
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prices of the iron and steel aluminium
zinc will lower the initial margin of
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the business due to the higher raw material cost now let's understand what are the
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measurement what are the drivers of the
liquidity risk see one of the prime
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measurement of the liquidity risk is the
application remember this thing
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application of the current ratio now the
current ratio is the value of the
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short-term liability as for the current
liability so the idle ratio is believed
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to be one which suggest as the we
suggest the firm has the capacity to pay
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its current liability for its short term
assets right let's move on to the next
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thing
now as you can see the graph on the
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screen 4 X 5 X and in the the XX
have the number of years in it so this
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is the example of so current ratio
now the holding stock fell by
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9.8%
on the back of the continuing losses and
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holy quarter results so shares balance
sheet doesn't look too good either and
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money morning has named a this company
as one of the 5 companies that may go
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bankrupt okay let's take another example
of liquidity risk of Ruchira Papers
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Limited which is an Indian company now
the following are the current assets and
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the you know the the current liabilities
of of the Ruchira Papers limited for the
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year ending financially a 17 and
18 and we can do the data as here
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from the revenue has grew close enough
to 6.14% on a no on
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yoy basis and the profit before tax has
increased by 25.39%
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40% with
the PPT margin the net profit margin
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has you can stood close enough to in the
neighbourhood of 7.6%
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at financially as 17 and 8.36
point financially 18
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and the current ratio was 1.31 versus one point four from
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financially at seventeen so this were
the couple of four examples that I'm
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giving you so that you can understand
what exactly goes wrong in in the
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company so what are the inferences that
you can make out of liquidity risk see
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there are some of the classic liquidity
examples in spite of the higher revenues
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and higher profitability the company's
current ratio has slipped marginally
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whereas the excessive inventory and
rising accounts receivable that is your
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debtors put pressure on the working
capital which results in what which
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results in the decrease which results in
the negative that is the decrease in the
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cash and cash equivalents and increase
in the short term borrowings so the
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future operation has to be done
carefully so as to so as to the account
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receivables that is the debtors to sales
should be less than the previous year
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AR to sales ratio and there should be an
increase in the cash and decrease in the
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short term borrowings some of the short
term liquidity crisis may lead to a long
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term you can see a negative impact
to the business so as for one of the ace
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investor
mr. Warren Buffett everyone knows him he
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says I have seen more people fall
because of the liquor and the leverage
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does mr. Buffett is emphasizing the term
leverage as borrowing or you can say
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dead right so as an example of liquidity
is the short term and the long term
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borrowing of Bhushan steel limited is
something as follow now this is the
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balance sheet data of Bhushan steel
limited for financial year 14 and 13 the
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shareholding funds year 9161 CR and in
13 so basically the shareholding funds
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have reduced the short term borrowings
have been increased the long term
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borrowing has been increased the total
borings has been significantly been
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increased so due to the poor operational
efficiency the business is being funded
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by these short term borrowing which has
increased by 20% closing 50s 20% and the
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long term borrowing has increased
thereby at least in the neighborhood of
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18 to 20 percent whereas the
shareholding wealth has got slapped or
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slashed by one person that is the debt
to equity ratio which should be ideally
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be less than one has increased to 2.47 r five in financially of 14
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versus 2.91 in financially or 13 so how
is this liquidity controlled now see
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there are several instances wherein the
expected loss is unexpected losses of
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the liquidity crunch could overcome the
smart liquidity risk management the
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first and the foremost thing is that you
know a short-term loan or the bank
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OD BOD can be taken the amount should be restricted to these future possible
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earnings and make this sure which the
company is going to receive in the
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coming years or days for example the
liquidity risk management or sundry debtors
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will be the pill incoming 15
days in hence the short term cash crunch
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can be met by taking a bank
ODP OD of the bill of the exchange and
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the second example that we can take in
case of the big order book has been
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cancelled and no amount has been
received against the bill and the
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manufacturing process has been started
then the liquidity risk management
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should not hinder
the walking process it should not hinder
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the working process rather than that the
liquidity risk management should
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communicate to the marketing team okay
so as to sell the excessive excessive
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reduction at the normal rate and so as
to incur the cost of production thank
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you everyone so that's it for this
particular topic if you have learned and
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