The Importance of Liquidity in the Financial System

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In finance, a company’s liquidity is the amount of cash or liquid assets it has easily available. It’s good business practice to look at liquidity, of cash flow and current ratios from time to time to determine the ‘general well-being’ of the entity. 

It’s possibly the first and most essential assessment required for making some business decisions such as whether or not to expand an enterprise, whether to invest excess funds, and if funds are needed from external sources.  

As liquidity refers to an enterprise’s state of financial health an enterprise’s ability to pay short-term obligations; liquidity also refers to its capability to sell assets quickly to raise cash.  

A company’s liquid assets can easily be converted into cash to meet financial obligations on short notice. Like in cases of financial emergency a company with adequate liquidity may have enough money available to pay its bills. 

A bank’s liquidity is determined by its ability to meet all its anticipated expenses, such as funding loans or making payments on debt, using only liquid assets. Banks need to hold enough to cover expected demands from depositors, creditors and counterparties. 

Cash equivalents and other assets (liquid assets) that can be easily converted into cash (liquidated). In the case of a market, a stock or a commodity, the extent to which there are sufficient buyers and sellers. To ensure that a few buy or sell orders would not move prices very much. Some markets are highly liquid; some are relatively illiquid.

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