In finance, what does 'liquidity' refer to?

Liquidity refers to the ability of an individual or organization to meet its short-term obligations, which is essential for maintaining operational continuity. In finance, a highly liquid asset is one that can easily be converted into cash without a significant loss in value. This concept is crucial for businesses as they need to ensure they can cover immediate expenses such as payroll, rent, and other operational costs.

For instance, cash itself is the most liquid asset, whereas physical assets like real estate may take longer to sell and convert to cash. Therefore, understanding liquidity helps assess an entity's financial health, ensuring it can respond to unexpected expenses or take advantage of opportunities that require immediate funding.