Liquidity

Cashing Out

What is liquidity?

Liquidity refers to how quickly and easily assets can be converted to cash.

An asset is liquid if it can be:

  • Easily exchanged
  • Quickly exchanged
  • Exchanged at little or no cost

Cash is the most liquid asset because it can be easily converted into other assets; for example, if someone wants to buy a $500 television, that person could easily pay for it in cash. It would be much harder, however, to use an antique that’s worth $500 to trade for the television because not many people would want to trade a television for an antique. Instead, the antique owner must sell the antique and then use that money to buy the television, which is a much longer and more difficult process.


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Examples of liquid assets


Examples of non-liquid assets

  • Real Estate
  • Art
  • Antiques
  • Coin Collection
  • Wine Collection

Liquidity measures both the number of buyers and sellers as well as the demand for the asset. An asset may have a high demand but low liquidity if buyers and sellers disagree on the value. On the other hand, everyone may agree on the price of an asset, but there may be few buyers or sellers.

Stock liquidity

An important component of this is the speed that you perform a transaction—the shorter the time between when you put up a share as a seller to when you find a buyer, the more liquid the stock.

If you’re investing in smaller companies, it’s important to remember that your ability to buy/sell stock will be limited by the number of buyers/sellers and can be more illiquid than the stock of larger companies.

Accounting liquidity

This is the measure of someone’s ability to have access to their money as they need it. To measure accounting liquidity, you have to compare liquid assets with current liabilities, which can be done through different ratio tests.

Ratio Tests

References

  1. http://www.investopedia.com/terms/l/liquidity.asp
  2. https://trendshare.org/how-to-invest/what-is-liquidity
  3. http://www.encyclopedia.com/topic/Liquidity.aspx

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