Glossary term
Liquidity Risk
Subject: Risk Management, Financial Risk (Credit, Market, Liquidity)
Liquidity risk is the risk that an organisation cannot meet its payment obligations when they fall due, or can do so only by raising cash at a heavy cost or selling assets at a loss.
Explanation
Liquidity is about cash timing rather than total wealth. A firm can be profitable and still run short of cash if customers pay late, lenders pull back or an asset cannot be sold quickly. Two forms are usually separated: funding liquidity risk, which is difficulty raising cash, and market liquidity risk, which is difficulty selling an asset without hurting its price. Banks are exposed because they borrow short and lend long, but any business with debts, suppliers or payroll faces it. Practitioners manage it with cash forecasts, buffers of liquid assets, diversified funding, committed credit lines, stress testing and contingency plans. Banks also follow regulatory ratios such as the liquidity coverage ratio. Treasury teams watch cash forecasts weekly, since a shortfall seen two months out can still be fixed.
Example
A construction company wins a large contract and spends heavily on materials, expecting a stage payment in 30 days. The client pays 60 days late. Payroll and supplier invoices fall due first. The company has valuable equipment but cannot sell it quickly, so it draws on an expensive short-term loan to bridge the gap.
Not to be confused with
- Solvency
- Solvency means assets exceed liabilities over time. Liquidity is having cash on hand when payments fall due.