'Flow Of Funds - FOF'

Flow of funds (FOF) accounts are collected and analyzed by a country's central bank. In the United
States, they are called Financial Accounts and are released by the Federal Reserve Bank approximately 10
weeks after the end of each quarter. 

The release, which the Fed labels Z.1, shows the assets and liabilities of each sector of the economy at the
end of the period in question. It also shows how each sector has served as a source and use of funds. It
includes a times series of outstanding debt for each sector of the economy, the derivation of net wealth in
the country by asset, and the distribution of gross domestic product (GDP). Detailed statements for each
account show how net capital has shifted to or from various sectors, allowing for a granular look at
movement of funds within the economy, as well as into and out of it.

The FOF accounts are used primarily as an economy-wide performance indicator. The data from the FOF
accounts can be compared to prior data to analyze the financial strength of the economy at a certain time
and to see where the economy may go in the future. The accounts can also be used by governments to
formulate monetary and fiscal policy.

The accounts use double-entry bookkeeping to track the changes in assets and liabilities in all sectors of
the economy: households, nonprofit organizations, corporations, farms, the government (federal, state and
local) and the foreign sector. A wide range of financial instruments is accounted for: Treasury assets,
American deposits abroad, savings deposits, money market funds, pension funds, corporate equities and
bonds, mutual fund shares, mortgages and consumer credits are just a few examples.

The Fed's annual flow of funds data extends back to 1945, with quarterly data available from the
beginning of 1952. The data provide a nuanced picture of how the size and composition of the U.S.
economy have changed since World War II. 

What is 'Liquidity'

Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market
without affecting the asset's price.

Market liquidity refers to the extent to which a market, such as a country's stock market or a city's real
estate market, allows assets to be bought and sold at stable prices. Cash is considered the most liquid
asset, while real estate, fine art and collectibles are all relatively illiquid.

Market Liquidity

In the example above, the market for refrigerators in exchange for rare books is so illiquid that, for all
intents and purposes, it does not exist. The stock market, on the other hand, is characterized by higher
market liquidity. If an exchange has a high volume of trade that is not dominated by selling, the price a
buyer offers per share (the bid price) and the price the seller is willing to accept (the ask price) will be
fairly close to each other. Investors, then, will not have to give up unrealized gains for a quick sale. When
the spread between the bid and ask prices grows, the market becomes more illiquid. Markets for real
estate are usually far less liquid than stock markets.

[ Note: Liquidity in the market can impact your ability to get in and out of a trade. Learn more about
how to navigate liquidity in our Investing for Beginners course on the Investopedia Academy. ]
Accounting Liquidity

For an entity such as a person or a company, accounting liquidity is a measure of ability to pay off debts
as they come due. In the example above, the rare book collector's assets are relatively illiquid and would
probably not be worth their full value of $1,000 in a pinch. In practical terms, assessing accounting
liquidity means comparing liquid assets to current liabilities, or financial obligations that come due within
one year. There are a number of ratios that measure accounting liquidity, which differ in how strictly they
define "liquid assets."

Current Ratio

The current ratio is the simplest and least strict ratio. Current assets are those that can reasonably be
converted to cash in one year.

Current Ratio = Current Assets / Current Liabilities

Acid-Test or Quick Ratio 

The acid-test or quick ratio is slightly more strict. It excludes inventories and other current assets, which
are not as liquid as cash and cash equivalents, accounts receivable and short-term investments.

Acid-Test Ratio = (Cash and Cash Equivalents + Short-Term Investments + Accounts Receivable) /
Current Liabilities

A variation of the acid-test ratio simply subtracts inventory from current assets, making it a bit more
generous:

Acid-Test Ratio (Var) = (Current Assets - Inventories) / Current Liabilities

Cash Ratio

The cash ratio is the most exacting of the liquidity ratios, excluding accounts receivable, as well as
inventories and other current assets. More than the current ratio or acid-test ratio, it assess an entity's
ability to stay solvent in the case of an emergency. Even highly profitable companies can run into trouble
if they do not have the liquidity to react to unforeseen events.

Cash Ratio = (Cash and Cash Equivalents + Short-Term Investments) / Current Liabilities

What is 'Solvency'

Solvency is the ability of a company to meet its long-term financial obligations. Solvency is essential to
staying in business as it asserts a company’s ability to continue operations into the foreseeable future.
While a company also needs liquidity to thrive, liquidity should not be confused with solvency. A
company that is insolvent must often enter bankruptcy.

Risks to Solvency

Certain events can create a risk to an entity’s solvency. In the case of business, the pending expiration of a
patent may pose risks to solvency as it will allow competitors to produce the product in question, and it
results in a loss of associated royalty payments. Further, changes in certain regulations that directly
impact a company’s ability to continue business operations can pose an additional risk. Both businesses
and individuals may experience solvency issues should a large judgment be ordered against them after a
lawsuit.

Solvency Vs. Liquidity

While solvency represents a company’s ability to meet long-term obligations, liquidity represents a
company's ability to meet its short-term obligations. In order for funds to be considered liquid, they must
be either immediately accessible or easily converted into usable funds. Cash is considered the most liquid
payment vehicle. A company that lacks liquidity can be forced to enter bankruptcy even if it is solvent if
it cannot convert its assets into funds that can be used to meet financial obligations.

'Profitability Ratios'

Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate
earnings compared to its expenses and other relevant costs incurred during a specific period of time. For
most of these ratios, having a higher value relative to a competitor's ratio or relative to the same ratio
from a previous period indicates that the company is doing well

Profit Margins

Different profit margins are used to measure a company's profitability at various cost levels, including
gross margin, operating margin, pretax margin and net profit margin. The margins shrink as layers of
additional costs are taken into consideration, such as cost of goods sold (COGS), operating and
nonoperating expenses, and taxes paid. Gross margin measures how much a company can mark up sales
above COGS. Operating margin is the percentage of sales left after covering additional operating
expense. The pretax margin shows a company's profitability after further accounting for nonoperating
expense. Net profit margin concerns a company's ability to generate earnings after taxes.

Return on Assets

Profitability is assessed relative to costs and expenses, and it is analyzed in comparison to assets to see
how effective a company is in deploying assets to generate sales and eventually profits. The term return in
the ROA ratio customarily refers to net profit or net income, the amount of earnings from sales after all
costs, expenses and taxes. The more assets a company has amassed, the more sales and potentially more
profits the company may generate. As economies of scale help lower costs and improve margins, return
may grow at a faster rate than assets, ultimately increasing return on assets.

Return on Equity

ROE is a ratio that concerns a company's equity holders the most, since it measures their ability of
earning return on their equity investments. ROE may increase dramatically without any equity addition
when it can simply benefit from a higher return helped by a larger asset base. As a company increases its
asset size and generates better return with higher margins, equity holders can retain much of the return
growth when additional assets are the result of debt use.