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Liquidity Ratios & Solvency Ratios - Explained in Hindi | #32 Master Investor - YouTube
Channel: Asset Yogi
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Many times you may have heard that a company is going to be insolvent
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Many companies are facing problems
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Now, what is solvency or insolvency?
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Sometimes we see some companies are facing liquidity problems
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Now, what is the difference between liquidity and solvency?
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It gets quite confusing
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In this video, we will see the difference between the two
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What is liquidity and what is solvency?
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And what are the liquidity ratios and solvency ratios?
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Through which you will know if the liquidity of any company is good or bad
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If the solvency of any company is good or bad
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Namaskar, my name is Mukul and you are welcome to the Asset Yogi
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Music
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So to understand the meaning of liquidity and solvency
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And to understand their difference
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We will take an example.
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We will not take an example of a company
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We will simplify it and we will talk about an individual
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Let's talk about me
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Assume I have some assets, I have already
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talked about what are assets in the previous videos
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The things which we own and that can be converted into cash in the future
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Let's say I have some assets, I have cash of 1 lakh Rs
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I have a house worth 40 lakhs Rs
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I have a car worth 5 lakh Rs
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I have some furniture
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And other small assets
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Their value is 4 lakh Rs in total
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So my assets in total will be 50 lakh Rs
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Now see,
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These assets of 5 lakh
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I may have made them by taking a loan
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And I may have some loans other than these
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So they are my liabilities
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So if calculate my total liabilities
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Let's see that also.
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Let's say I have a personal loan of 2 lakh Rs
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Let's say I have taken this for a year
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Then I have taken a home loan of 32 lakh Rs. Its value is 40 lakh Rs
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So I have taken a loan of 32 lakhs on this
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which I've taken for 20 years. Then I have a car loan for approx 3 lakh Rs
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This is a five-year loan. I have an education loan of 5 lakh Rs
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And let's say I've taken it for 5 years. So the total liabilities
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that we have is 42 lakh Rs
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As we talked earlier that if we calculate the net worth of an individual
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Then what is it?
Assets - Liabilities
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So I will deduct 42 lakes from 50 lakhs
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So what is my net worth? It is 8 lakhs Rs
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That means my net worth is positive
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When we talk about companies then we also call this net worth equity
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We have seen this in earlier videos.
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So till our net worth is positive
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We don't have an insolvency issue till then
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When does an insolvency issue arise?
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When our net worth becomes negative. How can that happen?
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Assume this is my house. Its value decreases from 40 lakhs
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Let's say the market falls and its value remains only 30 lakhs Rs
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Now we will see what other total assets remain?
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If we take this case, then the total asset remaining is
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I will add 30, 1, 5 and 4
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So the total assets are worth 40 lakhs in this case.
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My liabilities are the same. I have to pay the home loan of 32 lakhs
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Other loans are also the same
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What is my net worth in the second case?
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If I calculate a net worth of 2
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Then I have to deduct 42 lakhs from 40 lakhs.
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As you can see, my net worth is negative.
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My net worth is -2 lakhs. So now, it has become negative.
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We call insolvency to this negative net worth.
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If I have to pay all these liabilities
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immediately by any chance
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Let's say, I have a job and I lost a job
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So I have to pay all these liabilities all of a sudden
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Then I have to declare the bankruptcy
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What does that mean? My net worth has become negative
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So we call insolvency the same.
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This thing happens with the company
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when its liabilities increase to a very high extent
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Their assets can not fulfill them
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So sometimes the company has to declare the bankruptcy
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So we call this, solvency.
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The total overall position of solvency
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I will write it down here.
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This is basically your overall financial position
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Whether we talk about any individual
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or whether we talk about any company
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Now, what is liquidity?
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Let's understand liquidity. We will eliminate the example of 30 lakh
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We will come back to that example
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I have assets worth 50 lakhs Rs
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I have the same liabilities of 42 lakhs Rs
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But the liquidity means how is my financial position in the short term
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So if I talk about liquidity and short term
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So I can not sell a house immediately
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That will not come in short-term assets.
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What do we want in liquidity? I will write that here.
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In liquidity, first, we have to see our short term assets
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And second, we have to see our short term liabilities
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So we have talked about short term assets and short term liabilities earlier
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We are talking about less than a year.
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The assets which can be converted immediately into cash within
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a year are short term assets
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The liabilities that you have to pay within a year are short term liabilities
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See I have cash. These are my short term asset
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So I can take short term assets as 1 lakh
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So I will write 1 lakh here
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I have short term assets of 1 lakh
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I cannot sell a car immediately
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So I cannot consider it as short term liabilities
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I cannot sell furniture immediately
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I cannot take it as a short term asset
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On the other hand, there are liabilities. I have to take short term liabilities
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So the loan of 20 years, 5 years and the other loan of 5 years
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I will not consider them also.
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Let's say I have lost my job for example. So I have to pay my personal loan immediately
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If this gets default then the bank will say to pay these 2 lakh Rs immediately
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So my short term liabilities becomes 2 lakh Rs suddenly
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And I don't understand what to do next
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My short term assets cannot fulfill them
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I have only 1 lakh Rs cash. I cannot pay these 2 lakh Rs also
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So my short term assets are less than my short term liabilities
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That means my liquidity position is not good
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So your short term assets should always be more than your short term liabilities
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If we talk about companies
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then the short term position of the company should also be good
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And their long term position should also be good
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So this was the example of an individual
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The same thing applies to companies where we calculate the liquidity ratios
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and solvency ratios. By this, we get to know the short term financial position
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of the company by liquidity ratios and we will know the long term financial position
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by solvency ratio. So what are these ratios?
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Liquidity ratios are current ratios, quick ratio, and cash ratio
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In solvency ratios, the debt ratio comes
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Debt to equity ratio, interest coverage ratio, and debt service coverage ratio
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We will see all these ratios in detail one by one
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in the coming videos.
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