What does liquidity refer to in financial terms?

Liquidity in financial terms specifically refers to the ease and speed with which an asset can be converted into cash without significantly affecting its value. High liquidity indicates that an asset can be sold quickly, like cash or stocks that trade on a major exchange, while low liquidity is seen in assets such as real estate or collectibles, which may take longer to sell and might require a reduction in price to find a buyer quickly.

Understanding liquidity is crucial for individuals and businesses to manage their cash flow effectively. It allows them to ensure they have the necessary funds available when required, without incurring substantial losses. Financial instruments are often evaluated based on their liquidity because it impacts how quickly one can access cash from invested capital.