Liquidity has several different definitions and several different calculation methods, not all of which use cash flow. Financial liquidity refers to the ability of a business to pay off its debt obligations and generate cash flow. Asset liquidity describes how easily an asset can be converted into cash; this is otherwise known as marketability. Economic liquidity is a measurement of how quickly and cheaply businesses or individuals can get their hands on additional money through credit.

The common denominator between all of these definitions is the ease of acquiring cash. Higher liquidity means it is easier and less expensive to get cash. Lower liquidity means it is more difficult and expensive to get cash.

Calculating Financial Liquidity

There is no universal measurement of financial liquidity. Instead, companies use accounting ratios (liquidity ratios) such as the current ratio or the quick ratio to judge financial health. A company's assets can be found on the balance sheet and are usually listed in order of liquidity.

The operating cash flow ratio is sometimes used to describe liquidity. This can be calculated by dividing the operating cash flow by current liabilities.

Calculating Asset Liquidity

Asset liquidity, sometimes called market liquidity, is measured in terms of trading volume and the length of time that an asset remains on the market before finding a buyer. Stocks tend to be relatively more liquid because of the high volume of buyers and the fact that sellers can deduct losses from their taxes.

Currency trading in the forex market is considered extremely liquid, while the sale of physical assets is usually less so. Assets such as houses go through cycles of liquidity; liquidity is low during a sellers' market and high during a buyers' market.

Calculating Economic Liquidity

Macroeconomic liquidity is inexact because of the breadth of market indicators. The relative historical volume of bank loans is often used as a proxy for economic liquidity. The Federal Reserve targets liquidity by manipulating interest rates and setting bank reserve ratio requirements.

  1. What affects an asset's liquidity?

    Learn about what affects an asset's liquidity, including examples of liquid and fixed assets, and how a company's liquidity ... Read Answer >>
  2. Is it important for a company always to have a high liquidity ratio?

    Understand the significance of the liquidity ratio and how it is used in conjunction with other measures to arrive at an ... Read Answer >>
  3. What is the impact of inflation on liquid assets?

    Find out why inflation is particularly problematic for liquid assets, and learn what holders of liquid assets can do when ... Read Answer >>
  4. To what extent should you take a company's liquidity ratio into account before investing ...

    Find out how important it is for an investor to know a company's liquidity ratio before deciding to invest, and why relying ... Read Answer >>
Related Articles
  1. Investing

    Understanding Financial Liquidity

    Understanding how this measure works in the market can help keep your finances afloat.
  2. Investing

    Understanding Liquidity Risk

    Make sure that your trades are safe by learning how to measure the liquidity risk.
  3. Financial Advisor

    What Is The Quick Ratio?

    Find out about this liquidity indicator and how it's used.
  4. Investing

    Understanding Liquidity Risk

    Learn about the two types of liquidity risk: funding liquidity risk and market liquidity risk.
  5. Financial Advisor

    Small Cap Investing: How to Think About Illiquidity

    Do your homework, have a long term view, exercise patience, you'll find that investing in small market capitalization stocks is no riskier than investing in large stocks
  6. Investing

    What is Reduced Bond Liquidity and Why Does it Matter Now?

    Reduced bond liquidity caused investor concern earlier in the year, but some signs point to a resurgence going forward.
  7. Investing

    Using Liquidity Ratios

    Learn more about these quick and intuitive ratios you can use to analyze a stock's liquidity.
  8. Investing

    Working Capital Position

    Learn how to determine a company's working capital position to correctly analyze liquidity.
  9. Investing

    Explaining the Liquidity Preference Theory

    According to the liquidity preference theory, investors demand interest in return for sacrificing their liquidity.
  1. Liquid Asset

    An asset that can be converted into cash quickly and with minimal ...
  2. Liquid Market

    A liquid market is one where there are many bids and offers and ...
  3. Liquidate

    Liquidate means to convert assets into cash or cash equivalents ...
  4. Liquidity Ratios

    A class of financial metrics that is used to determine a company's ...
  5. Flight To Liquidity

    A situation where investors attempt to liquidate positions in ...
  6. Voluntary Liquidation

    A corporate liquidation that has been approved by the shareholders ...
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  3. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. ...
  5. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability of potential investments.
  6. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
Trading Center