What does liquidity risk entail?

Liquidity risk refers to the possibility that an organization will be unable to meet its short-term financial obligations due to an inability to access cash or cash equivalents quickly. This can occur if the company needs to sell assets to cover obligations but cannot do so without incurring substantial losses or delays. For example, if a company has a significant amount of its assets tied up in inventory or accounts receivable and needs cash urgently to pay suppliers, it could face liquidity risk if those assets cannot be quickly converted to cash.

In the context of financial management, being able to navigate liquidity risk is crucial for maintaining operational stability. Companies must ensure they have adequate liquid assets readily available to handle unforeseen expenses or cash flow timing issues.

The other options focus on different types of financial risk: capital investment losses relate to market or credit risk, interest rate fluctuations pertain to interest rate risk, and profit generation issues involve operational risk. Each of these risks is important, but they do not align directly with the definition of liquidity risk.