What are Liquid Assets?
Liquid assets don’t have anything to do with water: they’re ones that can quickly and easily turn into cash.
🤔 Understanding liquid assets
Like you or me, companies have bills to pay. Their bills might be larger or more complex, but they still need the cash to pay them. Liquid assets are the assets that a company can easily sell to pay its bills. Things that take time to sell, or that would lose a lot of value if sold quickly, aren’t included.
Let’s take a look at Apple. Apple’s liquid assets would be all of the cash it has in its bank accounts, plus anything else that it could quickly and easily sell for cash. This includes things like shares that the company recently bought back from shareholders or the iPhones the company has on the shelves in its stores.
By contrast, things that Apple can’t quickly sell and turn into cash, like patents for some of its products, would not be counted as liquid assets.
Picture an empty swimming pool that you want to fill with coins and dollar bills…
You want to fill up the pool in the next day or two. Any coins and bills that you already have can go right into the pool. Your liquid assets include all the cash that’s already in the pool, plus anything else that will sell quickly so you can fill the pool even more.
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What counts as a liquid asset?
Like liquid, liquid assets are assets that can easily flow, whether that be from owner to owner or place to place.
Anything that a company can use to pay its bills, such as cash, or that it can quickly and easily convert to cash counts as a liquid asset.
- Some examples of liquid assets are:
- Balances in a checking, savings, or money market account
- Mutual fund shares
Companies also include things that you might find on an income statement, such as their accounts receivable (money owing from customers/clients), and prepaid expenses (bills that they have paid in advance of their due date) as part of their liquid assets.
What are the most liquid assets?
Different assets have different levels of liquidity. While all liquid assets are relatively easy to convert into cash, some are easier to convert than others.
Of course, cash is the most liquid asset — it’s the definition of liquid. You can hand the money to someone to pay for a service or good that they provided to you, and there is no processing time for the transaction.
Cash equivalents, like the balance of a checking or savings account or things like commercial paper (it’s like a short-term IOU from a company), are also very liquid. They’re easy to convert to cash with little time and effort.
Stocks and longer-term bonds are also liquid assets but are less liquid than cash and cash equivalents. They’re considered liquid since there is a vast market for these securities, so selling them is likely to take very little time. However, processing the transaction and turning those securities into cash can be a hassle, making the cash less readily available than the other options we discussed.
Is a 401(k) a liquid asset?
401(k)s are complicated. If you’re old enough to make withdrawals from the account without paying the penalty, the money you have in the account is quite liquid. All you have to do to access it is withdraw it from the account.
If you’re not eligible to make a withdrawal without a penalty, the account is less liquid. Part of what makes an asset liquid is that you don’t take a significant loss when converting it to cash, so having to pay a penalty would make a 401(k) illiquid.
Is there a formula for liquid assets?
There isn’t a specific formula for determining whether an asset itself is liquid, but there is a formula that you can use to find out the value of a company's liquid assets. Just add the value of all of a company’s liquid assets to find the total amount.
If you want to find a company’s net liquid assets, which is the company’s liquid assets minus any of its current liabilities, you’ll subtract the following from the company’s liquid assets.
- Accounts payable
- The currently owed portion of long-term debt
- Taxes payable
- Other current liabilities
What is a solvency ratio?
Solvency ratios are a popular way for investors to get a quick idea of a company’s financial situation. Just as a company’s PE ratio compares a stock’s price and earnings, solvency ratios compare a company’s assets and liabilities.
One solvency ratio is the quick ratio: a company’s quick ratio measures a company’s ability to meet its immediate financial needs with just its most liquid assets. This includes things like cash, checking accounts, accounts receivable, and marketable securities.
You can calculate a company’s quick ratio using this formula:
Quick Ratio = (Cash and Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
The higher a company’s quick ratio, the more money it has available to cover its immediate expenses. If a company’s quick ratio is below 1, that means it doesn’t have enough immediately accessible money to cover its current liabilities.
A company’s current ratio is a less strict form of the quick ratio. This ratio compares all of a company’s assets that are expected to be liquidated within a year to all of the liabilities the company is expected to owe in the next year.
The formula for current ratio is:
Current Ratio = Current Assets / Current Liabilities
Investors can use these ratios to get a quick look at a company’s ability to cover its debts. As with all indicators, solvency ratios don’t tell the whole story but are a good place to start when researching a company.
What is a non-liquid asset?
A non-liquid asset is an asset that could not quickly and easily be converted into cash that can be used to pay a company’s bills.
Things like factory equipment, real estate, or technological patents are all assets. However, the process to sell them would take some time. For instance, selling real estate can easily take months, which means that a company couldn’t easily sell some land to pay a bill. That lack of ability to sell an asset to cover an immediate expense is what makes an asset non-liquid.
Do liquid assets show up on a balance sheet?
Companies do include their liquid assets on their balance sheet. Typically, the company will list assets on their balance sheet with the most liquid assets, like cash, at the top and less liquid assets at the bottom.
Is a credit card a liquid asset?
While your credit can increase your liquidity, it is not a liquid asset.
Liquid assets are just that: assets. They’re worth something and can be sold if you ever need cash for another purpose.
A credit card doesn’t have intrinsic value. You can’t sell the card to buy something else, which means that it is not an asset. What credit cards do is they make it easier for you to access a line of credit or debt. You’re effectively borrowing money from the credit card provider, which you then need to pay back at a later date. That means that you have more spending power available to you, but it does not make it an asset itself.
Why do liquid assets matter?
Liquid assets matter because they represent a company’s ability to pay for its expenses without having to sell off larger parts of its business.
To use a household example, imagine you just got a hospital bill for $10K. You have $5K in a checking account, own a house worth $250K and have no other valuable assets. To cover the bill, you’d have to sell your house, and you’d probably have trouble selling it before the bill’s due date.
The more liquid assets that a company has, the less trouble it will have paying its operating expenses and bills. Liquid assets also make companies more flexible, making it easier for them to quickly invest funds in new projects.
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