In this article
You might like
No items found.
See the latest spending trends for 25k+ companies on Ramp

Benchmark your company's expenses with Ramp's data.
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
Spending made smarter
Easy-to-use cards, spend limits, approval flows, vendor payments —plus an average savings of 5%.1
|
4.8 Rating 4.8 rating
Error Message
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
Get fresh finance insights, monthly
Time and money-saving tips,
straight to your inbox
|
4.8 Rating 4.8 rating
Thanks for signing up
Oops! Something went wrong while submitting the form.
Ready to partner with Ramp?
Time is money. Save both.
Ready to partner with Ramp?
Time is money. Save both.
Ready to partner with Ramp?
Time is money. Save both.
Table of contents

At its core, liquidity is a measure of how quickly an asset can be bought or sold without significantly impacting its price. Put another way, liquidity reflects how readily an asset can be exchanged for money without losing value in the process.

Cash itself is considered the most liquid asset because it can be used immediately to purchase goods or services. Other assets, like stocks, bonds, or real estate, must first be sold and converted into cash before they can be used.

Liquidity exists on a spectrum. Highly liquid assets, such as stocks of large, well-known companies, can be bought and sold quickly and easily with minimal impact on price. On the other hand, illiquid assets, like rare artwork or private company shares, may take longer to sell and often require significant discounts to attract buyers.

How liquidity works

To better understand how liquidity works, let's consider an example. Imagine you own two assets: shares of Apple stock and a rare, vintage sports car. 

If you needed to quickly raise cash, which asset would be easier to sell? Most likely, it would be the Apple stock. As a large, publicly-traded company, Apple has millions of shares outstanding, and there are always buyers and sellers in the market. You could sell your shares almost instantly at the current market price.

Now, consider the vintage car. While it may be valuable, the pool of potential buyers is much smaller. It could take weeks or months to find the right buyer willing to pay a fair price. And if you needed to sell quickly, you might have to accept a lower price than the car is worth.

In this example, the Apple stock is considered more liquid than the vintage car. The stock can be easily converted to cash, while the car requires more time and effort to sell.

How to measure liquidity

There are several ways to measure liquidity, depending on the context. For businesses, liquidity is often measured using financial ratios that compare a company's liquid assets to its short-term liabilities. Common ratios include:

  1. Current ratio = Current assets / Current liabilities
  2. Quick ratio (Acid-Test Ratio) = (Cash + Marketable securities + Accounts receivable) / Current liabilities
  3. Cash ratio = Cash and cash equivalents / Current liabilities 

TIP
What's considered a good liquidity ratio?
A higher ratio (or ratio greater than 1) indicates that a company has sufficient liquid assets to cover its short-term obligations, while a lower ratio suggests potential liquidity problems.

For stocks, liquidity is often measured by trading volume and bid-ask spreads. Stocks with high trading volumes and narrow bid-ask spreads are considered more liquid, as there are many buyers and sellers in the market, and transactions can be executed quickly with minimal impact on price.

Why is liquidity important?

Liquidity is crucial for businesses, investors, and financial markets as a whole. For businesses, having sufficient liquidity ensures they can meet short-term obligations, such as paying bills, salaries, and taxes. Companies with poor liquidity may struggle to operate smoothly and could face financial distress or even bankruptcy.

Investors also care about liquidity because it affects their ability to buy and sell assets quickly and at fair prices. Liquid markets, such as major stock exchanges, allow investors to easily enter and exit positions, which is essential for managing risk and seizing opportunities.

Moreover, liquidity is important for the overall stability of financial markets. When markets are liquid, there is less volatility, and prices are more stable. Illiquid markets, on the other hand, can be prone to sudden price swings and market disruptions.

Types of liquidity

Liquidity can be measured in two main ways: market liquidity and accounting liquidity. These two types of liquidity provide valuable insights into the financial health and stability of assets, companies, and markets.

Market liquidity

This type of liquidity refers to the ease with which assets can be bought and sold in a particular market without significantly affecting the asset's price. In highly liquid markets, there are many buyers and sellers, and transactions can be executed quickly and efficiently. Liquid markets are characterized by tight bid-ask spreads (the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept) and high trading volumes. Market liquidity is essential for investors, as it allows them to enter and exit positions easily and reduces the risk of being stuck with an illiquid asset.

Accounting liquidity

Accounting liquidity refers to a company's ability to meet its short-term financial obligations using its liquid assets. Liquid assets are those that can be easily converted into cash within a short period, such as cash, cash equivalents, and marketable securities. Financial ratios, such as the current ratio and the quick ratio, are used to assess a company's accounting liquidity. A higher ratio generally indicates better liquidity and a stronger ability to meet short-term obligations.

What is liquidity risk?

Liquidity risk is the danger that arises when an asset cannot be bought or sold quickly enough to prevent or minimize a loss. This risk is particularly relevant for investors holding illiquid assets, such as real estate, private company shares, or thinly-traded securities.

For example, consider a real estate investor who owns several rental properties. If the investor suddenly needs cash to cover an unexpected expense, they may be forced to sell one of their properties at a discount due to the time it takes to find a buyer. This is an example of liquidity risk.

Businesses also face liquidity risk when they hold assets that cannot be easily converted to cash. For instance, a company with a large inventory of unsold products may struggle to raise cash if sales decline unexpectedly.

To manage liquidity risk, investors and businesses can employ various strategies, such as:

  1. Diversifying their holdings across different asset classes and levels of liquidity
  2. Maintaining a buffer of cash or highly liquid assets to cover unexpected expenses
  3. Regularly monitoring liquidity ratios and adjusting as needed
  4. Having access to lines of credit or other funding sources in case of emergency

Discover Ramp's corporate card for modern finance

Liquidity in different markets

Liquidity plays a role in various financial markets, each with its own unique characteristics and challenges.

Stock market liquidity

In the stock market, liquidity is essential for efficient price discovery and smooth trading. Highly liquid stocks, such as those of large, well-known companies, can be easily bought and sold with minimal impact on price. These stocks typically have high trading volumes and narrow bid-ask spreads.

On the other hand, less liquid stocks, such as those of small, lesser-known companies, may have lower trading volumes and wider bid-ask spreads. This can make it more difficult for investors to enter or exit positions without affecting the price.

Bond market liquidity

Liquidity in the bond market can vary depending on the type of bond and market conditions. Government bonds, especially those issued by major economies like the United States, are generally considered highly liquid due to their low default risk and active secondary market.

Corporate bonds, on the other hand, can range from highly liquid (for large, well-known companies) to relatively illiquid (for smaller, less established firms). Bond market liquidity can also be affected by economic conditions, such as changes in interest rates or credit risk perceptions.

Real estate market liquidity

Real estate is often considered an illiquid asset class due to the time and costs involved in buying and selling properties. The liquidity of a particular property can depend on factors such as its location, property type, and market conditions.

During economic downturns or financial crises, real estate market liquidity can dry up as buyers become scarce and financing becomes more difficult to obtain. This can lead to significant price discounts for sellers needing to raise cash quickly.

Forex market liquidity

The foreign exchange (forex) market is one of the most liquid financial markets in the world, with a daily trading volume of over $6 trillion. The high liquidity of the forex market is due to its global nature, 24-hour trading, and the participation of a wide range of players, including banks, corporations, and individual investors.

However, not all currency pairs are equally liquid. Major currency pairs, such as EUR/USD or USD/JPY, typically have higher liquidity than less commonly traded pairs or those involving emerging market currencies.

Cryptocurrency market liquidity

Liquidity in the cryptocurrency market can vary significantly depending on the specific coin or token and the exchange platform. Bitcoin and Ethereum, the two largest cryptocurrencies by market capitalization, are generally considered the most liquid due to their high trading volumes and wide acceptance.

However, smaller cryptocurrencies or those with limited trading pairs may have lower liquidity, resulting in wider bid-ask spreads and more significant price impact from individual trades. Additionally, the cryptocurrency market is known for its high volatility, which can further exacerbate liquidity risks.

Ramp: Improving your business liquidity

For businesses looking to improve their liquidity, Ramp offers a suite of financial tools and services designed to streamline expense management and optimize cash flow.

With Ramp's corporate card and expense management platform, businesses can:

  • Set custom spend controls and limits to prevent overspending
  • Automate expense reporting and reconciliation, saving time and reducing errors
  • Gain real-time visibility into company-wide spending, enabling better decision-making
  • Access higher credit limits and longer payment terms to improve short-term liquidity
  • Earn cashback on purchases, providing an additional source of liquidity

By leveraging Ramp's tools and insights, businesses can better manage their liquidity, freeing up cash for growth and investment opportunities. To learn more about how Ramp can help your business optimize its liquidity, sign up today.

Try Ramp for free
Error Message
 
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
Contributor Finance Writer
John is a freelance writer and content strategist with over three years of experience and expertise covering topics on finance, HR/business, and IT security for small and medium-sized businesses. His work has been featured on reputable platforms like Forbes Advisor and Techopedia.
Ramp is dedicated to helping businesses of all sizes make informed decisions. We adhere to strict editorial guidelines to ensure that our content meets and maintains our high standards.

FAQs

Why Abode's CEO, Tyler Bliha, chose Ramp over Brex

"The reason I've been such a super fan of Ramp is the product velocity. Not only is it incredibly beneficial to the user, it’s also something that gives me confidence in your ability to continue to pull away from other products."
Tyler Bliha, CEO, Abode

How The Second City expedited expense management and gained financial control with Ramp

“Switching to Ramp for Bill Pay saved us not only time but also a significant amount of money. Our previous AP automation tool cost us around $40,000 per year, and it wasn’t even working properly. Ramp is far more functional, and we’re getting the benefits at a fraction of the cost.”

“Just do it:” How Bratjen Construction Modernized Processes, Saved Time, and Improved Accuracy with Ramp

“Prior to Ramp, we had a handful of cards that our owners and leadership had access to, but it was more of a trust based system. Ramp has allowed us to give cards to more people, but the controls in Ramp ensure that the cards are used properly.”
Michael Irvin, Director of Operations, Bratjen Construction

How MAGNA-TILES® implemented a corporate card program, reduced stress, and prepared to build with Ramp

"In my day-to-day, Ramp helps me resolve things quickly and expedite month-end close. From an overall holistic business standpoint, we now have the ability to quickly scale as we add new users. It’s kind of crazy how quickly things have grown here, and Ramp has been a great partner for us in that growth.”
Tim Borse, Assistant Controller, MAGNA-TILES

How Eventbrite streamlined processes and improved UX with Ramp

"The Ramp dashboard easily shows how many cardholders are paying for the same subscription. Now the procurement team has the information they need to negotiate a corporate package.”
Laura Moreno, Sr. Manager, Global AP, Eventbrite

How Boys & Girls Clubs of America improved efficiency, gained visibility over spend, and regained lost time with Ramp

How Evans Hotels saved time and gained spend visibility with Ramp

“Ramp has been a big win for us when it comes to transparency and visibility. If the executive team wants to dig into spend at a property or review purchases the teams are making, we can have that information really quickly and are confident it’s accurate.”
Caryn Fink, Director of Accounting, Evans Hotels