What is a liquid asset is a common question among the general population and rookie entrepreneurs who need to assess how much capital they have at their disposal. We will outline the definition of this widely used term and also give the answer to the question” how to calculate liquid assets?”
KEY TAKEAWAYS:
- A liquid asset is a property owned by a person or a company that can be converted into cash on hand in a short period of time.
- More funds available in liquid assets mean more financial security in unexpected financial situations like it is, e.g., recession.
- Cash in a bank account, stocks, bonds, and receivables all count as liquid assets, and each of these items can be added to the calculation formula.
- Liquid assets are especially important in business because enterprises constantly need working capital to pay their vendor’s and payroll-related bills.
What is a Liquid Asset?
An asset is a property owned by a person or a company that has value; it is available to meet debt and commissions etc., and can be converted to cash easily in a short period of time.
Liquid assets are a part of the net worth of a person or a company and are reported in financial statements. Liquid assets have a high demand and security.
Cash in hand can also be considered liquid assets, such as short-term bonds and accounts receivable!
For an asset to be a liquid asset, it has to fulfill several requirements. The asset should be in an established market with an abundance of willing buyers. The transfer of ownership of the assets must be safe and secure, and the transfer should be able to be completed in a short amount of time.
Liquid Assets Examples
Cash
Cash is the most known liquid asset of all. Cash in hand, cash in savings accounts, and cash in checking accounts all count as cash. The foreign currency also counts as cash, but the value may change with time because of changing exchange rates.
Cash Equivalents
Cash equivalents include the value of cash-like assets. They have high credit value and high liquidity.
Cash equivalents include stocks, short-term government bonds, treasury bills, and commercial papers. These can often gain more interest than cash, even though it isn’t as accessible as cash.
Marketable Securities
Marketable security can be a liquid asset depending on the holding duration in question. Not all marketable securities can be converted to cash quickly, so not all marketable securities are liquid assets.
Some marketable assets are mentioned as long-term assets on a company’s financial statements instead of current assets, making those non-liquid assets.
Accounts Receivable
Suppose a company or a person provides a customer with a product or a service on a credit basis. In that case, the company is due to receive the accounts receivable at the end of the credit period.
If the credit period is short enough, accounts receivable can be considered a liquid asset. However, this type of liquid asset can be unpredictable, so it’s not considered the most liquid of assets.
Inventory
Suppose there is a large market for a company’s inventory along with huge demand. In that case, the inventory can be considered a liquid asset because it can be converted into cash securely in a short amount of time!
However, because of events like inventory recession, inventory damage, and customer interest suddenly shifting into a newer model or a different product, the security of inventory as a liquid asset can be questionable.
How to Calculate Personal Liquid Assets
You can calculate your liquid assets by taking the cash you have on hand and adding assets that can be converted to cash quickly and safely, like accounts receivable funds!
Examples of personal liquid assets calculation:
Example 1
A person working as a commission artist has US$ 30,000 in her savings account and US$ 3,000 in her checking account. Additionally, she has US$ 5,000 invested in government bonds and US$ 400 as cash receivable from her clients in the near future.
Here’s how her personal liquid assets are calculated:
- = US$ 30,000 + US$ 3,000 + US$ 5,000 + US$ 400
- = US$ 38,400
Example 2
A clerk who works at a bank has US$ 50,000 saved in a savings account. He also has US$ 3,000 in a safety deposit box at home. He has invested US$ 4,000 on high-demand stocks from a popular media company as well.
Here’s how much his liquid assets are worth:
- = US$ 50,000 + US$ 3,000 + US$ 4,000
- = US$ 57,000
His personal liquid asset value will increase with interest generated in his savings account if the prices of the stocks he bought increase.
How to Calculate Personal Liquid Net Assets
To calculate your personal liquid net assets, simply find out how much you have in liabilities and subtract that amount from the total liquid asset sum.
If there is a liquidity discount that needs to be considered, take this into account!
Examples of personal liquid net assets calculation:
Example 1
A nurse has a total of personal liquid assets worth US$ 29,000, comprised of US$ 24,000 saved in a savings account and US$ 5,000 invested in government bonds. The nurse has liabilities worth US$ 15,000.
This is how the net personal liquid assets of the nurse are calculated:
- = US$ 29,000 – US$ 15,000
- = US$ 14,000
How to Calculate Liquidity Ratio
The generally used formula to calculate the liquidity ratio:
Liquidity ratio = Value of Liquid Assets / Current Liabilities
= (Cash and cash equivalents + Marketable Securities + Accounts receivable) /
Current Liabilities
Examples of liquidity ratio calculation:
Example 1
A company that distributes restaurant-grade kitchen utensils has US$ 400,000 saved in the company savings account. The company has market;e securities worth US$ 30,000 and US$ 50,000 in accounts receivable. The company in question has current liabilities worth US$ 100,000.
Here’s how the liquidity ratio of the company is calculated:
- = (US$ 400,000 + US$ 30,000 + US$ 50,000) / US$ 100,000
- = 4.8
Example 2
A company that mass produces instant coffee, hot chocolate, and milk tea has a liquid asset value of US$ 5 Million. US$ 3 Million is saved in a savings account, and US$ 2 Million is the value of the accounts receivable by this company.
The company currently has a current liability value of US$ 2 Million!
The liquidity ratio of the company is calculated as follows:
- = US$ 5 Million / US$ 2 Million
- =2.5
How to Increase Liquidity Ratio
- Consider selling excessive and unnecessary assets.
- Negotiate for longer debt cycles and longer payment plans.
- Pay bills beforehand.
- Reduce overhead expenses.
Summary
It is very straightforward to understand what liquid assets are, and we have outlined all interesting facts regarding this term that is often used by business people!