In the context of business accounting, liquidity represents the extent to which a company can meet financial obligations with cash and other “liquid” assets on hand. The quicker an asset can be used in a transaction, the more liquid it is (cash being the standard). Financial obligations can include asset purchases, insurance payments, and other current liabilities.
Types of Liquid Assets
Aside from cash, by and large considered the standard for liquidity (because of its immediate full worth), there are a number of other assets considered liquid:
- Funds kept in checking and savings
- Stocks and bonds
- Mutual funds
- Certificates of deposit
How A Company’s Liquidity is Determined?
There are three common ratios used to determine liquidity:
- Current ratio = current assets ÷ current liabilities
- Quick ratio = cash (+cash equivalents) + short-term investments + accounts receivable ÷ current liabilities
- Cash ratio = cash (+cash equivalents) + short-term investments ÷ current liabilities