Liquidity definition
/What is Liquidity?
Liquidity is the ability of an entity to pay its liabilities in a timely manner, as they come due for payment under their original payment terms. Having a large amount of cash and current assets on hand is considered evidence of a high level of liquidity.
When applied to an individual asset, liquidity refers to the ability to convert the asset into cash on short notice and at a minimal discount. Having an active market with many buyers and sellers typically results in a high level of liquidity. When an asset can only be sold off in short order at a steep discount, it is not considered to be very liquid.
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Why is Liquidity Important?
Liquidity is an essential issue for managers, because a business must always have sufficient cash available to pay for its obligations as they become due for payment. Otherwise, the business may need to seek bankruptcy protection. Consequently, the single most important issue for most treasurers and chief financial officers is whether the current assets of a business are properly aligned with its current liabilities. If not, they need to obtain alternative financing, such as a line of credit, to ensure that there is always enough cash in reserve to pay for obligations.
Examples of Liquid Assets
The more liquid assets are marketable securities and accounts receivable. Marketable securities can typically be sold within a day or two on an exchange, while receivables will be paid for within a few weeks, depending on the payment terms agreed to with customers.