People have indeed claimed that they are land poor. When an individual claim that they are land poor, it implies that they have significant real estate assets but little income. The land that such a person owns does not have much value because they do not have enough capital to the land or pay the relevant charges because of it. Describing a business as land poor implies that it has challenges meeting its short-term and long-term obligation despite having huge assets. The land poor concept provides the basis to understand and differentiate between solvency and liquidity.
Liquidity and solvency indicate an entity's ability to use current assets to honor its short term and long term debts. Solvency shows the robustness of a company's long-term financial position, which means that it has a positive net worth. Hence it can satisfy long-term financial needs. Differently, liquidity shows the capacity of a firm to meet its short-term obligation ( Yeo, 2016 ). From the perspective of an individual, a land poor person cannot use the properties to meet their short-term and long-term commitments.
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A company seeking a bank loan must prove that it can repay both short- and long-term obligations. Both concepts show how financially healthy business is before a bank can dispense a loan ( Yeo, 2016 ). For instance, if a business has a loan that should be paid in two years, the first year when payments are due is considered short-term while the second year is taken to be long-term. The two concepts cannot be interchanged because they are entirely different from each other. In the short-term, the bank will consider how fast the borrowing business can convert its current assets to pay off its current liabilities, which is the company's liquidity. Contrarily, solvency will show that the company will meet the loan obligation in the long-term. The bank is interested in the timing of repayment and not the category of debt, and this information is mostly indicated on the balance sheet. Concept-wise, liquidity has low risk, while solvency is high risk. In summary, the two augment each other in that if solvency is high, the entity can achieve liquidity with a short time. Solvency will not be quickly achieved if liquidity is high.
A business must prove its liquidity and solvency status before securing a loan from a bank. Balance sheets give useful information that can be used to identify a firm's solvency and liquidity position. Nevertheless, a balance sheet will show the solvency and liquidity on a given day. Therefore, if the bank wants to identify the solvency and liquidity of a business, it has to consider several consecutive balance sheets that will allow the lender to conduct a horizontal trend analysis. Such an analysis considers changes over time of a given measure, such as debt ratio ( Kundid & Marinović, 2016 ). As mentioned above, both concepts should be considered by a bank before it gives a loan to a business entity.
The two financial concepts have specific ratios that indicate a business's ability to finance short-term and long-term obligations. Firms use liquidity ratio to ascertain their ability to meet short-term debts. The liquidity ratios include the current ratio, the acid ratio, and the cash ratio. On the other hand, the solvency ratio is a key metric used to measure an entity's ability to satisfy its long-term debts. If a business's solvency ratio is low, it shows that there is a probability that it will default on its long-term obligations ( Yeo, 2016 ). The solvency ratio considers the cash flow of a business instead of net income because it does not look into debt alone but also cash management practices.
References
Kundid Novokmet, A., & Marinović, A. (2016). Solvency and Liquidity Level Trade-off: Does it Exist in Croatian Banking Sector? Scientific Annals of Economics and Business , 63 (3), 429-440. https://doi.org/10.1515/saeb-2016-0132
Yeo, H. (2016). Solvency and Liquidity in Shipping Companies. The Asian Journal of Shipping and Logistics , 32 (4), 235-241. https://doi.org/10.1016/j.ajsl.2016.12.007
