A:

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.

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