What is a ‘Liquid Asset’
A liquid asset is an asset that can be converted into cash quickly, with minimal impact to the price received in the open market. Liquid assets include money market instruments and government bonds. The foreign exchange market is deemed to be the most liquid market in the world because trillions of dollars exchange hands each day, making it impossible for any one individual to influence the exchange rate.
BREAKING DOWN ‘Liquid Asset’
Although there is no universal formula to calculate liquid assets, standard financial liquidity ratios determine and utilize liquid assets. These ratios – including the current ratio and quick ratio – manipulate the level of liquidity analyzed based on the underlying asset.
Features of Liquid Asset
A liquid asset must have an established market in which enough buyers and sellers exist so the market price of the asset cannot be manipulated or easily changed. A company must have the ability to transfer ownership of the asset quickly and easily for full market price. If a discount is applied to the selling price, the asset is considered to be illiquid.
Hierarchy of Liquid Assets
Assets are listed on the balance sheet in accordance to liquidity with the most liquid assets being listed first. For this reason, cash is always listed as the first current asset because it is the most liquid asset. Cash equivalents may be combined with cash on the top line because they represent demandable and convertible instruments available for immediate conversion. Cash is typically followed by marketable securities, accounts receivable, inventory, fixed assets and goodwill.
Importance of Liquid Assets
Liquid assets is an important classification to creditors and lenders. A company with higher amounts of liquid assets has a greater capability of paying debt obligations as they become due. Therefore, while reporting liquid or illiquid assets is not required for external purposes, management and some external entities such as banks or financial institutions find liquid asset totals useful in loan preparations. In addition, emergency funds are typically held in liquid assets for ease of access.
Example of Liquid Asset/Market
The stock market is an example of a liquid market because there is a large number of buyers and sellers, and certain stocks are examples of liquid assets. Because of its high trading volume, certain equitable securities may quickly be converted into cash. This is especially the case for stocks with high market capitalization and large share volume. Because stocks can be easily sold using electronic markets for full market prices on demand, equitable securities – under the right conditions – are liquid assets.