In accounting, liquidity (or accounting liquidity) is a measure of the ability of a debtor

Debtor

A debtor is an entity that owes a debt to someone else. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor...

 to pay his debts as and when they fall due. It is usually expressed as a ratio

Ratio

In mathematics, a ratio is a relationship between two numbers of the same kind , usually expressed as "a to b" or a:b, sometimes expressed arithmetically as a dimensionless quotient of the two which explicitly indicates how many times the first number contains the second In mathematics, a ratio is...

 or a percentage

Percentage

In mathematics, a percentage is a way of expressing a number as a fraction of 100 . It is often denoted using the percent sign, “%”, or the abbreviation “pct”. For example, 45% is equal to 45/100, or 0.45.Percentages are used to express how large/small one quantity is, relative to another quantity...

 of current liabilities.

Calculating liquidity

For a corporation with a published balance sheet

Balance sheet

In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...

 there are various ratios used to calculate a measure of liquidity. These include the following:

• the current ratio
  Current ratio
  The current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm's current assets to its current liabilities...
  
  , which is the simplest measure and is calculated by dividing the total current assets by the total current liabilities. A value of over 100% is normal in a non-banking corporation. However, some current assets are more difficult to sell at full value in a hurry.
• the quick ratio
  Quick ratio
  In finance, the Acid-test or quick ratio or liquid ratio measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. Quick assets include those current assets that presumably can be quickly converted to cash at close to their...
  
   - calculated by deducting inventories and prepayments from current assets and then dividing by current liabilities - gives a measure of the ability to meet current liabilities from assets that can be readily sold. A better way for a trading corporation to meet liabilities is from cash flows, rather than through asset sales, so;
• the operating cash flow ratio can be calculated by dividing the operating cash flow
  Operating cash flow
  In financial accounting, operating cash flow , cash flow provided by operations or cash flow from operating activities , refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investment in securities...
  
   by current liabilities. This indicates the ability to service current debt from current income, rather than through asset sales.

Understanding the ratios

For different industries and differing legal systems the use of differing ratios and results would be appropriate. For instance, in a country with a legal system that gives a slow or uncertain result a higher level of liquidity would be appropriate to cover the uncertainty related to the valuation of assets. A manufacturer with stable cash flows may find a lower quick ratio more appropriate than an Internet-based start up corporation.

Liquidity in banking

Liquidity is a prime concern in a banking environment and a shortage of liquidity has often been a trigger for bank

Bank

A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...

 failures. Holding asset

Asset

In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...

s in a highly liquid form tends to reduce the income

Income

Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...

 from that asset (cash, for example, is the most liquid asset of all but pays no interest) so banks will try to reduce liquid assets as far as possible. However, a bank without sufficient liquidity to meet the demands of their depositors

Deposit account

A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the...

 risks experiencing a bank run

Bank run

A bank run occurs when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent...

. The result is that most banks now try to forecast

Forecasting

Forecasting is the process of making statements about events whose actual outcomes have not yet been observed. A commonplace example might be estimation for some variable of interest at some specified future date. Prediction is a similar, but more general term...

 their liquidity requirements and maintain emergency standby credit

Credit (finance)

Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...

 lines at other banks. Banking regulators

Bank regulation

Bank regulations are a form of government regulation which subject banks to certain requirements, restrictions and guidelines. This regulatory structure creates transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things...

also view liquidity as a major concern.