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Liquidity

Candlefocus Editor

Liquidity is a concept used to measure the ability of an asset or security to be converted into cash quickly and without affecting its market price. Cash is the most liquid of assets; however, tangible items, such as homes and cars, are harder to convert into ready cash. This is because sense of their value can be more difficult to establish.

Liquidity can be divided into two types, namely market liquidity and accounting liquidity. Market liquidity refers to the degree to which an asset can be bought or sold in a market without significantly affecting the market price. Accounting liquidity focuses on a company's ability to pay off its short-term liabilities with its available assets. It is generally reflected in the current ratio and quick ratio, which are the two most commonly used tools for measuring liquidity.

The current ratio looks at a company's current assets compared to its current liabilities and allows investors to calculate a company's capacity to handle its liabilities in the near future. The quick ratio, or acid test, looks at a company's cash and cash equivalents only, which can be liquidated immediately. This metric is often used to supplement the current ratio, as it is considered to be a measure of a company's financial strength.

In conclusion, liquidity is an important concept in the financial world and it provides an indication as to how easily an asset can be converted into cash. Market liquidity considers how easy it is to trade an asset, while accounting liquidity focuses on a company's ability to pay its short-term liabilities. Current and quick ratios are the two most commonly used tools to measure liquidity.

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