Liquidation sales, liquid assets, liquidity ratio—maybe you’ve heard these terms before. If you’ve ever been a little hazy on what exactly liquidity means in the world of finance, this article can help.
Assets, Value, & Cash
Liquidity involves three factors: assets, value, and cash.
1. Assets: Simply put, an asset can be anything that is worth money. Take a look at whatever property you have, and you’ll see that a lot of things can be considered assets. Some might be on the larger side, such as land, homes, and vehicles. Other assets may be a little smaller, such as computers, furniture, or even clothing items.
2. Value: Value is how much money an asset is worth. This has the potential to be a bit objective at times, considering one man’s trash can be another man’s treasure. In general, however, there are ways of determining how much something is worth on the market. This is especially true for larger assets, such homes or vehicles. For example, a home appraisal can determine a fair asking price for a given house in the current market.
3. Cash: Tangible money that can be exchanged for goods and services. Cash itself can be considered an asset (known as a "liquid asset").
Liquidation is the act of converting an asset into cash. For example: Let’s say you own a car outright. The current market value of the car is $9,000. You decide to sell the vehicle, and the next day a buyer purchases it for $9,000. You have just liquidated the car. In other words, you exchanged it for cash at market value.
Liquidity measures how easily an asset can be liquidated. For instance, a Dream Checking account at Cyprus Credit Union offers high liquidity. This is because you can easily access the funds in your account and withdraw cash at a branch or ATM. There is no minimum required balance and no set withdrawal limits.
In the previous example of the car, the car offered moderate liquidity. Selling the vehicle was not as simple as making simple cash withdrawal from a checking account, but the car was liquidated fairly quickly at market value.
An example of an asset with generally low liquidity is real estate. This is because the process of selling land can be complicated and lengthy. It could take some time before you complete the selling process and see the profit from it.