We all like to have full control of our money, but do we really know what we are doing and how? Today we tell you the importance of having the 3 pieces of the financial profitability puzzle in harmony: security, liquidity and profitability.
When we talk about profitability, we refer to the relationship that exists between the benefits that an operation provides us with, and the effort or investment that has been made for it, in a few words, it is the benefit that you obtain with respect to the money that you used to make the investment. Generally, short-term profitability is usually lower than in the long term, just as investments with higher risk usually have higher profitability.
The profitability of a good or an asset will always be based on its capacity to produce interest or yields. Next, we will recreate an example of a financial investment:
Let’s imagine that Juan makes an investment of €5,000 with a return of 12%. In addition, Juan has financed with his own funds the value of €2,700 and the rest (€2,300) with a loan of 7% per year.
To calculate the profitability that Juan obtains from the investment, we multiply 12% by the investment of €5,000 and we get a total of €600.
Next, we subtract the cost of the acquired loan from the return, i.e.: €2,300 x 7% = €161. From here, we will calculate the net profit that Juan obtains in order to be able to calculate the financial profitability: BN: 600€ – 161€ = 439€.
Juan’s financial profitability: FR: (BN ÷ Equity) x 100 = (439 ÷ 2,700) x 100 = 16.26€.
Liquidity is the capacity of a person, financial entity or company to be able to cover and meet its financial obligations. When we talk about liquidity, we also talk about the capacity of an asset to be converted into cash. The more liquidity you have, the more capacity you will have to face your expenses and tasks, as well as to come out unscathed from any crisis that may come your way.
We are sure you have heard the phrase “no risk, no gain”, haven’t you? Well, in the world of finance and investments, this phrase makes perfect sense, since, when we talk about investments, the safer they are, the less profitable they are.
What is the relationship between the three concepts?
The relationship between security, liquidity and profitability can be either indirect, when for example one of the factors is high and the other not so high, or direct, when for example one of the values is very high and the other very high.
In any case, there are 3 different scenarios:
The more liquidity, the more security there will be and less profitability: If a financial asset has a lot of capacity to be converted into cash, the greater the security of the investment, i.e. it will not have much risk, and in turn, the lower the profitability.
If the security is lower, the lower the liquidity and the higher the profitability: It is not the same to leave money to someone who you know will return it to you, than to someone who is known as “the defaulter”.
The lower the liquidity, the greater the security and the higher the profitability: If it is very difficult to convert an asset into money, the higher the profitability and the greater the security, since in this case, we do not relate profitability with a significant risk.
In conclusion, it is very difficult, if not impossible, to find the perfect investment in which the 3 magic factors are high. However, a good analysis of the profitability, security and liquidity of an asset can lead us to make an investment that is beneficial, thus satisfying our interests and desires.
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