What does the term 'liquidity' refer to in finance?

Liquidity in finance refers specifically to the ability of an asset to be quickly converted into cash without significantly impacting its market price. This characteristic is crucial for individuals and businesses as it determines how readily they can access funds for operations, investments, or unforeseen expenses.

For example, cash is considered the most liquid asset because it can be used immediately for transactions. In contrast, real estate or collectibles are less liquid because selling them quickly may take time and could require accepting a lower price than their valuation.

Understanding liquidity is vital for financial planning, as it helps assess the ability to meet short-term obligations and manage cash flow effectively.