Liquidity measures your wealth strength. How much cash or cash equivalent assets you own. Liquidity affects financial decisions and investments. We shall get into the details and evaluate it’s implication from different perspectives.

Definition Of liquidity

Liquidity means the ability of converting an asset into cash. Cash is the most liquid asset among all other types of assets as it can be used any time at rapid pace and ease. Cash equivalent i.e. stocks, options, bonds etc. are included in cash equivalent. Some less liquid assets like certificates of deposit are converted into cash at their maturity. If it is done before maturity then we have to face a penalty.

It is always important know about assets liquidity level so that at times they can be sold quickly to convert them in cash. Borrowing is another way of obtaining cash. Borrowing can be in various forms. It could be a private loan from an individual or from banks. One can borrow more funds from banks quickly as compared personal loans from individuals.

Bank is a financial institution, playing the role of intermediaries between lenders and borrowers.

The Stock Market Liquidity

Same is the case with stock market. If shares are sold easily and quickly then market is liquid. The buying and selling of shares affect stock prices. The trade of shares is depends on the investors preferences and interests. If stocks trade on major stock exchanges it is considered more liquid as investors are keener to invest or trade these stocks. If stock trades on pink sheets and over the counter it is less liquid due to less trading activities and less interest of traders. Spread of Bid or Ask Price can also be used as a measure of liquidity. It is about 1% of trading price for liquid assets and larger for illiquid assets.Before you place order must know about liquidity of the stock. For placing a limit order on major stock exchanges you will get desired price during normal market hours. This practice is ideal for non liquid companies.

Companies Liquidity

Most important thing that investors consider is the liquidity of the company they are investing funds. Cash for any company is alike an oxygen for human. It means company without cash can not survive. It will go bankrupt and fold up because it can not meet due obligations and operating expenditures to run the business.

Current Ratio is important tool to measure the liquidity of a company. It considers the current assets and current liabilities. The term Current refers to a period of one year or less than a year. Company must own twice assets compared to obligations. It means ratio of two or more is better.

Quick Ratio or Acid Test Ratio takes current liabilities and net current assets into account. Net asset means we do not include inventory in the current assets. It is not easily converted into cash. Ration more than one is considered better. Other ratio that is important is D/E Ratio. It considers Debt and Equity of the company.

It refers to the level of debt or borrowing. How much company assets are financed by outsiders and insiders? It affects liquidity of a firm. More of debt borrowing lessens the liquidity.

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