Liquid Asset Definition


What Is a Liquid Asset?

A liquid asset is an asset that can easily be converted into cash in a short amount of time. Liquid assets include things like cash, money market instruments, and marketable securities. Both individuals and businesses can be concerned with tracking liquid assets as a portion of their net worth. For the purposes of financial accounting, a company’s liquid assets are reported on its balance sheet as current assets.

Understanding Liquid Assets

A liquid asset is cash on hand or an asset that can be easily converted to cash. In terms of liquidity, cash is supreme since cash as legal tender is the ultimate goal. Assets can then be converted to cash in a short time are similar to cash itself because the asset holder can quickly and easily get cash in a transaction exchange.

Liquid assets are often viewed as cash, and likewise may be called cash equivalents because the owner is confident the assets can easily be exchanged for cash at any time.

Generally, several factors must exist for a liquid asset to be considered liquid. It must be in an established, liquid market with a large number of readily available buyers. Ownership transfer must also be secure and easily facilitated. In some cases, the amount of time to cash conversion will vary.

The most liquid assets are cash and securities that can immediately be transacted for cash. Companies can also look to assets with a cash conversion expectation of one year or less as liquid. Collectively, these assets are known as a company’s current assets. This broadens the scope of liquid assets to include accounts receivable and inventory.

Overall, liquid assets are very important for individuals and businesses because they are the first source of cash used in meeting payment obligations.

Balance Sheet Accounting

In financial accounting, the balance sheet breaks assets down by current and long-term with a hierarchical method in accordance to liquidity. A company’s current assets are assets a company looks to for cash conversion within a one-year period. Current assets have different liquidity conversion timeframes depending on the type of asset. Cash on hand is considered the most liquid type of liquid asset since it is cash itself.

Cash is legal tender that an individual or company can use to make payments on liability obligations. Cash equivalents and marketable securities follow cash as investments that can be transacted for cash within a very short period, often immediately in the open market. Other current assets can also include accounts receivable and inventory.

On the balance sheet, assets become less liquid by their hierarchy. As such, the long-term assets portion of the balance sheet includes non-liquid assets. These assets are expected for cash conversion in one year or more. Land, real estate investments, equipment, and machinery are considered types of non-liquid assets because they take time to convert to cash, costs can be incurred to convert them to cash, and they may not convert to cash at all.

Many non-liquid, long-term assets usually require depreciation considerations because they are not expected to be easily sold for cash and their value is decreasing while they are in use.

READ:  Nominal Definition

Examples of Liquid Assets

Examples of liquid assets held by both individuals and businesses include:

  • Cash
  • Money market assets
  • Marketable equity securities (stocks)
  • Marketable debt securities (bonds)
  • U.S. Treasuries maturing within one year or actively traded in the secondary market
  • Mutual funds
  • Exchange-traded funds (ETFs)
  • Accounts receivable
  • Inventory

Analyzing Liquid Assets

In business, liquid assets are important to manage for both internal performance and external reporting. A company with more liquid assets has a greater capability of paying debt obligations as they become due.

Companies have strategic processes for managing the amount of cash on their balance sheet available to pay bills and manage required expenditures. Industries like banking have a required amount of cash and cash equivalents that the company must hold to comply with industry regulations.

There are several key ratios analysts use to analyze liquidity, often called solvency ratios. Two of the most common are the quick ratio and the current ratio. In the current ratio, current assets are used to assess a company’s ability to cover its current liabilities with all of its current assets and to survive unplanned and special circumstances like a pandemic.

The quick ratio is a more stringent solvency ratio that looks at a company’s ability to cover its current liabilities with just its most liquid assets. The quick ratio does include accounts receivable.

The quick ratio and the current ratio are key financial statement ratios used to break down liquidity levels and analyze solvency.

Liquid and Non-Liquid Markets

Both individuals and businesses deal with liquid and non-liquid markets. Cash as supreme is the ultimate goal for liquidity and ease of conversion to cash generally separates the distinction of a liquid vs. non-liquid market but there can also be some other considerations.

A liquid asset must have an established market in which enough buyers and sellers exist so that an asset can easily be converted to cash. The market price of the asset should also not be significantly changed, resulting in less liquidity or greater illiquidity for subsequent market participants.

The stock market is an example of a liquid market because of its large number of buyers and sellers which results in easy conversion to cash. Because stocks can be sold using electronic markets for full market prices on demand, publicly listed equity securities are liquid assets. Liquidity can vary by security, however, based on market capitalization and average share volume transactions.

The foreign exchange market is deemed to be the most liquid market in the world because it hosts the exchange of trillions of dollars each day, 24 hours a day, making it impossible for any one individual to influence the exchange rate. Other liquid markets include commodities and secondary market debt.

Illiquid Markets

Illiquid markets have their own considerations and constraints. These factors can be important for individuals and investors when allocating for liquid vs. non-liquid assets and making investment decisions.

For example, a real estate owner may wish to sell a property to pay off debt obligations. Real estate liquidity can vary depending on the property and market but it is not a liquid market like stocks. As such, the property owner may need to accept a lower price in order to sell the property quickly. A quick sale can have some negative effects on the market liquidity overall and will not always generate the full market value expected.

Another type of controversial illiquid asset may include private market fixed income which can be liquidated or traded but less actively. Overall, in considering illiquid assets, investors usually apply some type of liquidity premium which requires a higher yield and return for the risk of liquidity.

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