Liquidity refers to the availability of cash or cash equivalents to meet short-term operating needs. In other words, liquidity is the amount of liquid assets that are available to pay expenses and debts as they become due. Obviously, the most liquid asset of all is cash.
Liquidity is the capacity of an entity to settle its liabilities promptly, as they fall due for payment under their original terms. Possessing a substantial amount of cash and current assets on hand is considered indicative of a high level of liquidity.
When applied to an individual asset, liquidity pertains to the ability to convert the asset into cash quickly and at a minimal discount. Having an active market with numerous buyers and sellers typically results in a high level of liquidity. If an asset can only be sold off quickly at a substantial discount, it is not deemed very liquid.
Liquidity is a crucial concern for managers because a business must always have enough cash available to settle its obligations as they become due for payment. Otherwise, the business may need to seek bankruptcy protection. Consequently, the paramount issue for most treasurers and chief financial officers is whether the current assets of a business are appropriately aligned with its current liabilities. If not, they need to secure alternative financing, such as a line of credit, to ensure that there is always enough cash in reserve to settle obligations.
The more liquid assets include marketable securities and accounts receivable. Marketable securities can typically be sold within a day or two on an exchange, while receivables will be paid within a few weeks, depending on the agreed payment terms with customers.
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