A:

In finance, liquidity management takes one of two forms based on the definition of liquidity. One type of liquidity refers to the ability to trade an asset, such as a stock or bond, at its current price. The other definition of liquidity applies to large organizations, such as financial institutions. Banks are often evaluated on their liquidity, or their ability to meet cash and collateral obligations without incurring substantial losses. In either case, liquidity management describes the effort of investors or managers to reduce liquidity risk exposure.

Liquidity Management in Business

Investors, lenders and managers all look to a company's financial statements, using liquidity measurement ratios to evaluate liquidity risk. This is usually done by comparing liquid assets and short-term liabilities. Companies that are over-leveraged must take steps to reduce the gap between their cash on hand and their debt obligations.

All companies and governments that have debt obligations face liquidity risk, but the liquidity of major banks is especially scrutinized. These organizations are subjected to heavy regulation and stress tests to assess their liquidity management because they are considered economically vital institutions. Here, liquidity risk management uses accounting techniques to assess the need for cash or collateral to meet financial obligations.

Liquidity Management in Investing

Investors still use liquidity ratios to evaluate the value of a company's stocks or bonds, but they also care about a different kind of liquidity management. Those who trade assets on the stock market can't just buy or sell any asset at any time; the buyers need a seller, and the sellers need a buyer.

When a buyer cannot find a seller at the current price, he or she must usually raise his or her bid to entice someone to part with the asset. The opposite is true for sellers, who must reduce their ask prices to entice buyers. Assets that cannot be exchanged at a current price are considered illiquid.

Investors and traders manage liquidity risk by not leaving too much of their portfolios in illiquid markets. In general, high-volume traders in particular want liquid markets, such as the forex currency market.

RELATED FAQS
  1. What is liquidity risk?

    Learn how to distinguish between the two broad types of financial liquidity risk: funding liquidity risk and market liquidity ... Read Answer >>
  2. 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 >>
  3. 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 >>
  4. What investments are considered liquid assets?

    In this article, you'll learn what liquid assets are, what assets are considered liquid, and what investments are considered ... Read Answer >>
Related Articles
  1. Investing

    Understanding financial liquidity

    Financial liquidity comes into play for companies, your personal finances, investing, and the financial markets. However, assets and investments have varying liquidity levels.
  2. Investing

    ETF Liquidity: Why It Matters

    Lower levels of liquidity in exchange-traded funds make it harder to trade them profitably.
  3. Investing

    A Guide To ETF Liquidation

    There are a lot of ETF options, but not all have staying power. Learn what happens when an ETF fails.
  4. Investing

    Working Capital Position

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

    Liquid & Illiquid Assets

    The easier it is to convert the asset, the more liquid the asset is considered.
  6. Investing

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  7. Tech

    Bitcoin Liquidity: What The Stakes Are

    Liquid markets are easy to exit; illiquid markets can put traders in a tough spot. Here are the main factors affecting the liquidity of Bitcoins.
  8. Investing

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  9. Managing Wealth

    When Introducing Illiquidity to Your Portfolio Makes Sense

    Find out when you should consider adding illiquid investments to your portfolio, such as real estate or locked-up investment funds.
RELATED TERMS
  1. Liquidity Risk

    Liquidity risk refers to the marketability of an investment and ...
  2. Flight To Liquidity

    A situation where investors attempt to liquidate positions in ...
  3. Liquidator

    A liquidator is a person or entity that liquidates something, ...
  4. Overall Liquidity Ratio

    Overall liquidity ratio is the measurement of a company’s capacity ...
  5. Liquidity

    Liquidity is the degree to which an asset or security can be ...
  6. Dollar Volume Liquidity

    The price of a stock or ETF multiplied by its daily trading volume ...
Hot Definitions
  1. Investment Advisor

    An investment advisor is any person or group that makes investment recommendations or conducts securities analysis in return ...
  2. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  3. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  4. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  5. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  6. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
Trading Center