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Before You Start Investing: Assess Your Investment Risk — Types of Liquidity
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Types of Liquidity

Types of Liquidity

Market Liquidity is liquidity that applies to markets. The stock market is considered very liquid. The bid price and ask price for a share are usually pretty close, and investors don’t have to give up their unrealized gains if they want to sell quickly. On the other hand, the real estate market is considered to have low liquidity. A seller who wants to sell property quickly will have to give buyers a discount, and thus will likely not receive the full value of the property.

Liquidity is important for many reasons, but primarily because it impacts how quickly you can open and close positions. A liquid market is generally associated with less risk, since there is usually always someone willing to take the other side of a given position. A liquid market is more attractive to investors, which adds to the favorable market conditions.

Accounting Liquidity is a measure of how easily an individual entity can sell their assets in order to pay their debts. For instance: a rare painting may be valuable. Yet a fine art collector may not be able to get the full value for the painting over a short time compared to someone with an equal amount of cash. Accounting liquidity is expressed as a ratio comparing liquid assets to current liabilities.

Assets are items or resources producing economic value that are owned or controlled by a company. 

Current liabilities are short-term financial obligations of a company due within a year or a normal operating cycle.

In our further chapters, we'll take a closer look at how you can analyze business liquidity to your benefit.