Firstly liquidity is the quantity of cash businesses have promptly obtainable a bit like water in a well that is readability available to quench your thirst.

The word Liquidity within the money world refers to the ease with which an asset (equity shares, debentures, etc.) can be traded in the stock market in exchange for currency. Liquidity risk portrays the risks related to such trades, as the conversion of the asset into money can also depend on various parameters such as book value of a company, bid-ask spreads, etc.

It is the risk associated with the company in which a company fails to meet the ability to immediate or short-term financial obligations without incurring major losses.

Liquidity risk has nothing to do with the net worth of a company. For example, a company has crores of rupees tied up in their manufacturing equipment but does not have sufficient liquid cash to pay their staff and suppliers. Such drawback affects the company expansion of its business and hence cash and cash equivalent play a crucial role in the balance sheet of the company.

The prime cause for liquidity risk is too much dependence on short-term sources of funds i.e. the cash inflow from the sources of funds is always unpredictable.

Liquidity risk also correlates to market risk. For example, selling off property cannot occur on a quick basis since it is a highly illiquid asset and also depends on the demand in the market for it.

Liquidity risk associated with Bonds:

In regards to investing, the bid-ask spread is the major factor to measure liquidity. Bid-Ask unfolds is that the distinction between what an emptor is willing to pay and a trafficker is willing to just accept.

In bonds, the liquidity risk is the risk associated with the investor where the bond is expected to sell at a price lower than the expected price.

In order to measure the liquidity risk, it is important to know what the company owns in liquid assets and what it owes. Market liquidity risk can be measured on how quickly a company can exit illiquid assets such as property.

Liquidity risk management is highly important for the smooth functioning of businesses. For example, 2020 showed a major economic downfall wherein formerly profitable businesses went cash crunch. In order to protect your business from financial impacts identifying the risk, assessing the impact, and mitigating the risk is important.