Legal Definitions - liquidity

Liquidity refers to how easily an asset or investment can be converted into cash without significantly losing its value. An asset that is highly liquid can be sold or exchanged quickly at its fair market price, whereas an illiquid asset may take a long time to sell or require a substantial price reduction to find a buyer.

• Example 1: Personal Savings

  Imagine someone needs to pay an unexpected medical bill immediately. The money held in their checking account is highly liquid because they can access it instantly through an ATM or bank transfer, converting it to cash without any loss in value. In contrast, if their primary asset was a rare stamp collection, selling it quickly to cover the bill would likely involve finding a specialized buyer and potentially accepting a lower price than its true market value, making the stamp collection less liquid.

  Explanation: This illustrates liquidity by comparing an asset that is immediately convertible to cash at full value (checking account) with one that requires time and potentially a price concession to convert (rare stamp collection).

• Example 2: Business Operations

  A small business that sells popular electronics typically has a significant portion of its inventory considered liquid assets. If the business needs to raise cash quickly, it can often sell these common items relatively fast, perhaps through a sale, without drastically cutting prices. However, a specialized manufacturing company might own custom-built machinery designed for a very niche production process. If that company needed to sell the machinery to raise cash, it would likely take a long time to find a specific buyer and might have to sell it at a much lower price than its original cost, making the machinery a very illiquid asset.

  Explanation: This example demonstrates how the ease and speed of converting inventory or specialized equipment into cash differ, highlighting the concept of liquidity in a business context.