Liquidity is the ability to convert capital to cash. It is an important consideration for businesses and individuals as liquidity is required to meet financial obligations such as payroll and bills. Some types of capital are considered liquid and others are aren't. The following are common examples of liquidity.
CashCash of a major currency is considered completely liquid.
Restricted CashLegally restricted cash deposits such as compensating balances against loans are considered illiquid.
Marketable SecuritiesFinancial instruments that can be bought and sold on a public market. The liquidity of marketable securities relates to the daily trading volume of the security. A government bond with high trading volumes is considered almost as liquid as cash. A small cap stock with little volume is considered illiquid.
Cash EquivalentsCash equivalents include marketable securities and other cash-convertible instruments such as treasury bills and commercial paper.
CreditUnused credit such as a line of credit may help an entity to achieve liquidity. Such facilities may be subject to terms that make them far less reliable than cash in a liquidity crunch. For example, if a global financial crisis occurs banks may have incentive to revoke lines of credit.
AssetsAssets such as inventory, receivables, equipment, vehicles and real estate aren't considered liquid as they can take many months to convert to cash. In the event of financial stress, such assets can become difficult to covert to cash at all.
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