External liquidity refers to the availability of funds from sources outside of a company, which can be used to meet its financial obligations. It plays crucial role in the financial health and stability of a business, as it provides the necessary cash flow to support day-to-day operations, make investments, and manage unexpected expenses. In this article, we will explore the concept of external in more detail, its importance for businesses, and some common sources of external liquidity.
Import of External Liquidity:
Adequate external liquidity is essential for a company to maintain its operations smoothly and seize potential growth opportunities. It allows businesses to meet their short-term obligations, such as paying employees, suppliers, and creditors on time. Additionally, having access to external funds can enable businesses to invest in new projects, expand their operations, and develop new products or services. Furthermore, external liquidity acts as a buffer against unexpected events or financial crises, providing companies with the ability to navigate through challenging times without resorting to drastic measures such as downsizing or bankruptcy.
Sources of External Liquidity:
There are several sources from which a company can obtain external liquidity. However, it is worth noting that each source may have its own advantages, disadvantages, and eligibility criteria. Some common sources of external liquidity include:
Bank Loans:
One of the most traditional and widely used sources of external liquidity is bank loans. Companies can approach banks or financial institutions to secure funds based on their creditworthiness and ability to repay the loan amount within the agreed terms. Bank loans can be either short-term (typically repaid within one year) or long-term (repayable over a longer period).
Lines of Credit:
A line of credit is a flexible borrowing arrangement that allows businesses to have access to funds whenever needed. This form of external liquidity provides companies with the convenience of borrowing money only when required, thereby reducing interest costs. Lines of credit may be secured or unsecured, depending on the creditworthiness of the borrower.
Trade Credit:
Trade credit refers to the credit extended by suppliers to their customers. It allows companies to purchase goods or services and defer payment until a later date. Trade credit terms can vary, with some suppliers offering a short payment period (e.g., net 30 days) and others providing more extended credit periods (e.g., net 90 days). This form of external liquidity is particularly relevant for companies that rely heavily on their suppliers.
Issuance of Bonds or Debentures:
Larger companies, particularly those with a strong credit rating, may opt to issue bonds or debentures in order to raise external liquidity. These financial instruments are typically purchased by institutional investors or the general public and represent a long-term borrowing arrangement for the issuing company. Bonds or debentures generally have a fixed interest rate, repayment term, and can be traded in secondary markets.
Equity Financing:
Another source of external liquidity is equity financing, whereby companies issue shares or ownership stakes in exchange for investment. Common methods of equity financing include initial public offerings (IPOs), private placements, or venture capital investments. Equity financing provides companies with a permanent source of external liquidity, as the funds obtained do not typically require repayment but instead grant investors ownership rights in the company.
Government Grants or Subsidies:
Depending on the industry and geographical location, businesses may be eligible for government grants or subsidies. These programs aim to support specific sectors or activities deemed socially or economically beneficial. Government grants or subsidies can help companies access external liquidity without incurring debt or diluting ownership.
External liquidity is a crucial aspect of financial management for businesses across various sectors. It ensures that a company can meet its obligations, pursue growth opportunities, and manage unforeseen financial challenges. By taking advantage of diverse sources of external liquidity such as bank loans, lines of credit, trade credit, bond issuances, equity financing, and government grants, companies can maintain a healthy financial position and drive long-term success. A comprehensive understanding of the importance of external liquidity and the available sources is essential for businesses to make informed decisions and secure the necessary funding to achieve their strategic objectives.
