The FTX blowup shows that some investors don’t understand the difference between:
(1) illiquidity and (2) insolvency
Grab a seat. Let’s go:
(1) illiquidity and (2) insolvency
Grab a seat. Let’s go:
1/ Illiquidity
Let’s talk about the opposite for a second
What is liquidity?
If a company is “liquid” it means that it can pay its current liabilities using current assets
Let’s talk about the opposite for a second
What is liquidity?
If a company is “liquid” it means that it can pay its current liabilities using current assets
What are current liabilities?
Debt the company owed to external parties due in less than 1 year. It includes:
• Accounts Payable
• Payroll
• Taxes
• Loan payments
Debt the company owed to external parties due in less than 1 year. It includes:
• Accounts Payable
• Payroll
• Taxes
• Loan payments
A company is considered “liquid” when it can pay these obligations using its current assets
Current assets include things like:
• Cash
• Accounts receivable
• Inventory
• Securities
Current assets include things like:
• Cash
• Accounts receivable
• Inventory
• Securities
In essence, when a company can pay its current liabilities using cash or current assets that can be CONVERTED easily into cash (for example via collecting accounts receivable or selling inventory)
The company is considered to be LIQUID
The company is considered to be LIQUID
Being illiquid is problematic but it doesn’t break a company
The problem is “fixable”
If you don’t have enough cash sitting in the bank, you can try to find sources of cash or raise cash to pay your current liabilities
The problem is “fixable”
If you don’t have enough cash sitting in the bank, you can try to find sources of cash or raise cash to pay your current liabilities
This is done via:
• Getting a credit line
• Selling assets to raise cash
• Raising cash from investors
Conclusion:
Liquidity issues are stressful but are short-term and fixable
• Getting a credit line
• Selling assets to raise cash
• Raising cash from investors
Conclusion:
Liquidity issues are stressful but are short-term and fixable
2/ Insolvency
Insolvency is a worse situation than illiquidity
A company that is insolvent is one that cannot cover its total liabilities with total assets.
Insolvency is a worse situation than illiquidity
A company that is insolvent is one that cannot cover its total liabilities with total assets.
As an example, FTX could not repay its customers and debtors to whom it owed money to
Therefore, FTX became insolvent and was forced to declare bankruptcy
Therefore, FTX became insolvent and was forced to declare bankruptcy
Insolvency is usually the first step a company would face before declaring bankruptcy
A company that is insolvent, will go to its creditors to try to work out a solution to remedy the situation
A company that is insolvent, will go to its creditors to try to work out a solution to remedy the situation
This can be done via:
• Getting relief on debt payments
• Raising cash from investors or other debtors
If nothing can be done, the company files for bankruptcy
• Getting relief on debt payments
• Raising cash from investors or other debtors
If nothing can be done, the company files for bankruptcy
3/ How insolvency happened at FTX
(based on my understanding of events)
1. FTX was supposed to hold money for its customers
2. Instead, the money was given by FTX to a related party and parked in FTT tokens
(based on my understanding of events)
1. FTX was supposed to hold money for its customers
2. Instead, the money was given by FTX to a related party and parked in FTT tokens
3. A tweet from a competitor triggered the value of the FTT token to drop
4. Customers started to demand FTX to give their money back
5. FTX couldn’t pay its customers because their money was parked in FTT tokens which became worthless
4. Customers started to demand FTX to give their money back
5. FTX couldn’t pay its customers because their money was parked in FTT tokens which became worthless
6. Since FTX could not repay its customers, it tried to raise cash but failed
7. FTX becomes insolvent and declared bankruptcy
7. FTX becomes insolvent and declared bankruptcy
If you enjoyed this thread, retweet it so other people can benefit!
Follow @AliTheCFO
I tweet about:
• Finance
• Business Frameworks
• Personal Growth
Follow @AliTheCFO
I tweet about:
• Finance
• Business Frameworks
• Personal Growth
Loading suggestions...