{"id":40300,"date":"2022-08-12T12:16:46","date_gmt":"2022-08-12T12:16:46","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=40300"},"modified":"2025-03-15T10:38:43","modified_gmt":"2025-03-15T10:38:43","slug":"source-and-factors-affecting-liquidity","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/source-and-factors-affecting-liquidity\/","title":{"rendered":"Source and Factors affecting Liquidity"},"content":{"rendered":"\n<p><\/p>\n<p>Liquidity management describes a company&#8217;s ability to generate cash when needed to meet its short-term obligations. Effective liquidity management means that a company can manage its major sources of liquidity efficiently. Although these major sources tend to vary from one company to another, they typically include primary and secondary sources of liquidity.<\/p>\n<p> <\/p>\n<h3 class=\"wp-block-heading\">Primary Sources of Liquidity<\/h3>\n<p> <\/p>\n<p>Primary sources of liquidity refer to funds that are readily accessible to a company at a relatively\u00a0low cost. They can be held as cash or cash equivalents and include:<\/p>\n<p> <\/p>\n<ul class=\"wp-block-list\">\n<li>Available cash balances. The liquidation of near-cash securities, investment income, and bank balances are three examples.<\/li>\n<li>Short-term funds. These consist of the company&#8217;s short-term investment portfolios, trade credit, and bank lines of credit.<\/li>\n<li>Free\u00a0cash flows. These are operating cash flows after taxes, less short- and long-term investments.<\/li>\n<li>This demonstrates how well the organization&#8217;s cash management processes are working. A firm&#8217;s free cash flow will be more limited the more decentralized the company is.<\/li>\n<\/ul>\n<p> <\/p>\n<h3 class=\"wp-block-heading\">Secondary Sources of Liquidity<\/h3>\n<p> <\/p>\n<p>Secondary sources of liquidity include:<\/p>\n<p> <\/p>\n<ul class=\"wp-block-list\">\n<li>Negotiating debt contracts to reduce the burdens of high interest; payments, or principal repayment;\u00a0<\/li>\n<li>Liquidating assets; and<\/li>\n<li>Filing for bankruptcy protection and reorganization.<\/li>\n<\/ul>\n<p> <\/p>\n<p>Using secondary sources of liquidity can impact a company&#8217;s financial and operating positions, unlike primary sources of liquidity, which usually have no such impact. Using secondary sources of liquidity can also signal that a company&#8217;s financial health worsens and leads to liquidity being provided at a higher cost than usual.<\/p>\n<p> <\/p>\n<h3 class=\"wp-block-heading\">Drags and Pulls on Liquidity<\/h3>\n<p><strong>Drag on Liquidity<\/strong><\/p>\n<p> <\/p>\n<p>The timing of cash receipts and disbursements can significantly affect a company&#8217;s liquidity position. When receipts infrequently occur, especially after payments are made, a &#8216;drag on liquidity&#8217; occurs due to the decreased availability of funds. Drags on liquidity include:<\/p>\n<p> <\/p>\n<ul class=\"wp-block-list\">\n<li>Uncollected receivables;<\/li>\n<li>Obsolete inventory; and<\/li>\n<li>Tight credit.<\/li>\n<\/ul>\n<p><strong>Pull on Liquidity<\/strong><\/p>\n<p> <\/p>\n<p>Additionally, when disbursements are paid too early, a &#8216;pull-on liquidity&#8217; occurs because companies will be forced to spend money before receiving funds from sales that could cover their obligations. Pulls on liquidity include:<\/p>\n<p> <\/p>\n<ul class=\"wp-block-list\">\n<li>Making payments early;<\/li>\n<li>Reduced credit limits;<\/li>\n<li>Limits on short-term lines of credit; and<\/li>\n<li>Low liquidity positions.<\/li>\n<\/ul>\n<p> <\/p>\n<blockquote>\n<p><strong>Question<\/strong><\/p>\n<p> <\/p>\n<p>Which of the following are\u00a0<em>most likely<\/em>\u00a0primary sources of liquidity?<\/p>\n<p> <\/p>\n<ol class=\"wp-block-list\" style=\"list-style-type: upper-alpha;\" type=\"A\">\n<li>Negotiating debt contracts and liquidating assets.<\/li>\n<li>Ready cash balances and short-term funds.<\/li>\n<li>Filing for bankruptcy and cash flow management.<\/li>\n<\/ol>\n<p> <\/p>\n<p><strong>Solution<\/strong><\/p>\n<p> <\/p>\n<p>The correct answer is<strong>\u00a0B.<\/strong><\/p>\n<p> <\/p>\n<p>Readily available cash balances and short-term funds are examples or primary sources of\u00a0liquidity.<\/p>\n<p> <\/p>\n<p><strong>A is incorrect.<\/strong> Negotiating debt contracts and liquidating assets are examples of\u00a0secondary sources of liquidity.<\/p>\n<p> <\/p>\n<p><strong>C is incorrect.<\/strong>\u00a0Whereas cash flow management is a primary source of liquidity,\u00a0filing bankruptcy is a secondary source of liquidity.<\/p>\n<\/blockquote>\n<p> <\/p>\n","protected":false},"excerpt":{"rendered":"","protected":false},"author":15,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[25],"tags":[],"class_list":["post-40300","post","type-post","status-publish","format-standard","hentry","category-corporate-issuers","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Sources and Factors Affecting Liquidity | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Explore the key sources of 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