Money Management: Liquidity & Credit

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  • 0:00 Money Management,…
  • 0:43 What Is Liquidity
  • 1:54 What Is Credit?
  • 3:21 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

Whether it's for your small business or your personal finances, liquidity and credit are two critical financial concepts you need to understand. In this lesson, we'll define these two terms and discuss what they mean to you.

Money Management, Liquidity & Credit

Personal money management is just as important to your future as budgeting and finance is to the Chief Financial Officer of a large company. In fact, as we talk about financial concepts in this lesson, think of them in terms of how they impact you, the CFO of your family or yourself.

Both liquidity and credit are financial concepts that you can control. They also both have financial benefits and costs. Something that you can't turn into cash quickly (for example, a house) can be a very important and productive investment. These assets can also offer a financial rate of return. Holding cash, the most liquid asset, comes at a cost.

What Is Liquidity?

So, Mr. CFO, let's talk about liquidity. Liquidity refers to how easily an asset can be turned into cash. Let's think about two assets: a car and a $1,000 U.S. savings bond. If you owned these two things and experienced something that required you to get cash now, which of those two assets could you turn into cash the quickest?

The $1,000 savings bond could be turned into cash by taking it to a bank. Your car would need to be advertised and, once you found a buyer, you'd need to complete paperwork, all before getting paid. Between those two assets, which one is the most liquid? The answer is the savings bond because it's the easiest to turn into cash.

After that short description, Mr. CFO, how would you answer when someone asks, 'What percentage of my assets should be liquid?' Hopefully, your answer would be 'it depends.' The liquidity of your general portfolio - in this context, your general portfolio is basically everything you own or all the assets you have - depends on your cash flow needs. If you make just enough to pay your bills each month, you need to stay much more liquid than if your paycheck more than covered your monthly obligations.

What Is Credit?

Credit can be defined as the ability of the individual or organization to access borrowed money. When someone takes out a student loan, purchases a house with a mortgage or pays for dinner on a credit card, they're using credit. That is credit that some bank, based on an analysis of the individual's financial worthiness, has decided the individual can use responsibly and pay back at some future date.

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