what is liquidity 
liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price the most liquid asset of all is cash itself consequently the availability of cash to make such conversions is the biggest influence on whether a market can move efficiently the more liquid an asset is the easier and more efficient it is to turn it back into cash less liquid assets take more time and may have a higher cost tara anand investopediaunderstanding liquidityin other words liquidity describes the degree to which an asset can be quickly bought or sold in the market at a price reflecting its intrinsic value cash is universally considered the most liquid asset because it can most quickly and easily be converted into other assets tangible assets such as real estate fine art and collectibles are all relatively illiquid other financial assets ranging from equities to partnership units fall at various places on the liquidity spectrum for example if a person wants a 1 000 refrigerator cash is the asset that can most easily be used to obtain it if that person has no cash but a rare book collection that has been appraised at 1 000 they are unlikely to find someone willing to trade the refrigerator for their collection instead they will have to sell the collection and use the cash to purchase the refrigerator that may be fine if the person can wait for months or years to make the purchase but it could present a problem if the person has only a few days they may have to sell the books at a discount instead of waiting for a buyer who is willing to pay the full value rare books are an example of an illiquid asset there are two main measures of liquidity market liquidity and accounting liquidity market liquidity refers to the extent to which a market such as a country s stock market or a city s real estate market allows assets to be bought and sold at stable transparent prices in the example above the market for refrigerators in exchange for rare books is so illiquid that it does not exist the stock market on the other hand is characterized by higher market liquidity if an exchange has a high volume of trade that is not dominated by selling the price that a buyer offers per share the bid price and the price that the seller is willing to accept the ask price will be fairly close to each other investors then will not have to give up unrealized gains for a quick sale when the spread between the bid and ask prices tightens the market is more liquid when it grows the market instead becomes more illiquid markets for real estate are usually far less liquid than stock markets the liquidity of markets for other assets such as derivatives contracts currencies or commodities often depends on their size and how many open exchanges exist for them to be traded on accounting liquidity measures the ease with which an individual or company can meet their financial obligations with the liquid assets available to them the ability to pay off debts as they come due in the example above the rare book collector s assets are relatively illiquid and would probably not be worth their full value of 1 000 in a pinch in investment terms assessing accounting liquidity means comparing liquid assets to current liabilities or financial obligations that come due within one year there are several ratios that measure accounting liquidity which differ in how strictly they define liquid assets analysts and investors use these to identify companies with strong liquidity it is also considered a measure of depth measuring liquidityfinancial analysts look at a firm s ability to use liquid assets to cover its short term obligations generally when using these formulas a ratio greater than one is desirable the current ratio is the simplest and least strict it measures current assets those that can reasonably be converted to cash in one year against current liabilities its formula would be the quick ratio or acid test ratio is slightly more strict it excludes inventories and other current assets which are not as liquid as cash and cash equivalents accounts receivable and short term investments the formula is a variation of the quick acid test ratio simply subtracts inventory from current assets making it a bit more generous the cash ratio is the most exacting of the liquidity ratios excluding accounts receivable as well as inventories and other current assets it defines liquid assets strictly as cash or cash equivalents more than the current ratio or acid test ratio the cash ratio assesses an entity s ability to stay solvent in case of an emergency the worst case scenario on the grounds that even highly profitable companies can run into trouble if they do not have the liquidity to react to unforeseen events its formula is liquidity examplein terms of investments equities as a class are among the most liquid assets but not all equities or other fungible securities are created equal when it comes to liquidity some options and stocks trade more actively than others on stock exchanges more activity means that there is more of a market for them in other words they attract greater more consistent interest from traders and investors in addition to trading volume other factors such as the width of bid ask spreads market depth and order book data can provide further insight into the liquidity of a stock so while volume is an important factor to consider when evaluating liquidity it should not be relied upon exclusively these liquid stocks are usually identifiable by their daily volume which can be in the millions or even hundreds of millions of shares when a stock has high volume it means that there are a large number of buyers and sellers in the market which makes it easier for investors to buy or sell the stock without significantly affecting its price on the other hand low volume stocks may be harder to buy or sell as there may be fewer market participants and therefore less liquidity for example on march 13 2023 69 6 million shares of amazon com inc amzn traded on exchanges by comparison intel corp intc saw a volume of just 48 1 million shares indicating it was somewhat less liquid but ford motor co f had a volume of 118 5 million shares making it the most active and presumably most liquid among these three stocks on that day 