Liquidity Risk
Categories: Trading
See: Liquidity Squeeze.
Our company, Yacht Sea, Inc., makes and sells yachts. We love what we do, but economic recessions can really do a number on our profit margin. When financial times are tough, people tend to buy fewer yachts. (Crazy, we know.) In fact, the recent recession has landed us in a rather troubling situation: we don’t know if we’re going to be able to pay our short-term debts without causing the company to go under.
This is what’s known as “liquidity risk,” and the term can be applied to businesses, financial institutions, and individuals alike.
So what can we do about it? Well, if our lenders decide our liquidity risk is just too great, they might force us to sell off some assets to cover our debts. Or, if we know the recession is ending and we’ll be able to sell more yachts soon, we can try and negotiate with the lender and see if we can work out a short-term financing plan that will enable us to make payments toward our debt...and at the same time avoid liquidating the company’s assets.
Related or Semi-related Video
Finance: What is liquidity preference?27 Views
finance a la shmoop. what is liquidity preference?
yeah well liquidity is a good thing you want it. being liquid means that you have
cash which gives you options to you know buy stuff. and yeah even the Amazon River [money leaves a wallet in the grocery store]
shops at Amazon. all right so if your flavor of
investment has a liquidity preference over someone else's then your investment
all else being equal is preferable. see the liquidity preference . specifically if
you have liquidity preference and usually this is found in the form of
early stage of venture capital investor term sheets for investing in companies
in the form of convertible preferred stock- like it converts into common at
the IPO or something like that- then you get paid before everyone else
gets paid -at least in this form of stock- if the company gets sold.
all right well technically that is, but the company is sold and your convertible
preferred hasn't converted into common shares yet this company didn't go public. [convertible stock made into common stock]
but so like let's think about the example where if the company raised
twelve million bucks in preferred stock, which all had a liquidity preference
over and above common ,and then the whole company was sold for just fifteen
million dollars. well then those with liquidity preference would get liquid
first .ie they get their twelve million bucks. then the remaining three million
would be sprinkled around everyone else who was do the dough. plus any dividends
or accrued assets that have come our way otherwise. and yes technically debt
holders get paid ahead of the various series preferred investors who then get [list of who gets paid first]
paid ahead of the common shareholder but that's a different video. all right so
when it comes down to it you want to have liquidity preference. clearly I
prefer to be liquid myself. [man floats in lake in an inner tube]