How is liquidity defined in the context of financial management?

Liquidity in financial management refers specifically to the ability of a company to meet its short-term obligations. This encompasses the readiness of a company to fulfill its immediate financial liabilities, such as accounts payable, short-term loans, and other debts due within a year. Indicators of liquidity include ratios like the current ratio and quick ratio, which assess the company's ability to use its most liquid assets—primarily cash and cash equivalents—to pay off these short-term liabilities.

Understanding liquidity is essential because a company may be profitable yet still face financial difficulties if it cannot adequately manage its short-term cash flows. Therefore, maintaining appropriate liquidity levels ensures that a business can operate smoothly and avoid solvency issues down the line.