In economic terms, an asset is liquid if it can easily be converted into cash. In other words, something that you can sell easily is more liquid because you can sell it, get cash, and use your cash to buy something else. Money (in the sense of M1) is the most liquid form of assets.
Liquidation, then, is the process of making your assets more liquid. It tends to refer to the process of selling assets that are less liquid to get cash. A typical way to use this term is in reference to a firm that is going out of business. It sells its assets (machinery, for example) which are not liquid in order to get cash that can be used to pay off creditors and/or to be distributed to the owners of the firm.