In the simplest terms possible, a liquid asset is a commodity that can be used to raise money by a company, on an immediate basis. Liquidity of an asset is defined as its ability to provide cash as soon as possible. A company has a plethora of assets in its possession at any time in its operation, and occasionally some needs arise that require to be met with immediate effect.
In order to meet these needs (which include overhead expenses, unforeseeable payments and other items), a company will need instant money at its disposal. While it is considered good business sense to have some liquid assets in possession, it is also advisable to not keep hold of too many liquid assets at any given moment. If this is the case, then the company will soon realize that a large amount of money is just being kept in reserve and not contributing towards improving the company's profitability in any way. Hence, the liquidity ratio of a company is a very sensitive issue, and should be dealt with appropriately.
Examples of Liquid Assets
The best example of a liquid asset is the cash reserve that a company keeps. This reserve can be used by the company to meet any unexpected needs as and when they arise, and these needs can be met as soon as they are felt. It is always best for any company to keep sufficient cash reserves that are easily accessible, but it is also necessary to not keep a very large amount of cash in this reserve. Excessive storage of cash will render it useless, since it can be put to many other uses for the benefit of the business.
Here are some more liquid asset examples, that every business organization must stock up every once in a while. Keep in mind that liquid assets imply assets that can be exchanged for cash or for other goods that can be exchanged for cash, as soon as possible.
- As already mentioned above, the primary liquid asset of a company is the cash reserves that it has. Other items like commercial paper also amount as cash, since they can be exchanged for hard cash very quickly.
- Tradeable securities are also quantifiable as liquid assets, as long as the company buys and sells them on a recurring basis. When the need for cash arises, these securities can be sold and the market value for them can be collected. Other securities that are not tradeable, but are still available for sale, also count as liquid assets for a business organization.
- There are some securities that a company holds till their maturity period. These are also included in the list of liquid assets, even though the company knows for a fact that their liquidity is not very high.
- There are plenty of account receivables that a company also holds, and these are people and parties that owe the business some money. This includes debtors and other collectible accounts of customers. If the company feels the need for money strongly, it can press these debtors to repay their due amounts.
These are some of the general examples of liquid assets for a business organization, and they also include other items like bonds, certificates of deposit, credit union shares, mortgages, mutual funds, promissory notes, stocks, tax refunds and trust funds.
Importance of Liquid Assets
The Liquidity Ratio of a business organization, also known as the Acid Test Ratio or the Quick Ratio, is of great importance because it indicates the ability of a company to raise cash on a short notice. Any business that has a healthy liquidity ratio will appeal to investors, and an unhealthy liquidity ratio inversely implies that the company will be unable to meet short term needs, or that the company is stocking up large amounts of cash that can be used to get returns elsewhere.
The liquid ratio is calculated by simply dividing the liquid assets with the current liabilities of the company, and this gives a worthwhile indicator to the company's financial experts, as well as speculators and investors. It is generally believed that a liquidity ratio of 1:1 is satisfactory, but this depends from business to business and should not be followed blindly. As long as such a ratio is maintained, the company can at least meet all of its expenses if they arise suddenly.
Maintaining liquidity should be one of the primary aims of every company, no matter what industry they operate in. Every business comes with a certain degree of risk after all, and the company should have the ability and the cash to meet any unexpected expenses when they arise.