A liquid asset is a type of asset that can be quickly converted to cash within a short period of time. This type of asset is like cash in hand because it can be sold quickly and there won’t be any impact on the value of the asset. Liquid assets are important because you can easily pay the liabilities by converting liquid assets into cash.
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- 1 What Are Liquid Assets?
- 2 What Are The Key Factors Of Liquid Assets?
- 3 Importance Of Liquid Assets
- 4 Security
- 5 Flexibility
- 6 Allocation
- 7 FAQs About Liquid Assets
What Are Liquid Assets?
Liquid assets are something that you own and have the capacity to be easily converted to cash. Some examples of liquid assets are your business inventory, accounts receivable, stocks, cash, money market instruments, etc. For a business, liquid assets are a part of the main capital that is required to maintain ongoing business operations. It is very important for a business to have a certain level of cash reserve so that it can maintain its daily expenses. However, it is not a good practice to keep an excessive amount of liquid assets because unwarranted excess liquid assets should be used for long-term business expansion. Liquid Asset Examples:
1. Mutual funds
2. Exchange-traded funds (ETFs)
3. Accounts receivable
5. Marketable equity securities (stocks)
6. Marketable debt securities (bonds)
7. U.S. Treasuries maturing within one year
9. Money market assets
What Are The Key Factors Of Liquid Assets?
There are several factors available that make an asset a liquid asset. The asset must be in an established market and there should be a large number of interested buyers. Moreover, the ownership of the asset must be transferred easily. Below are some questions that define liquid assets –
1. How quickly the asset could be sold
2. How established the market is for that asset
3. How easily the ownership could be transferred
Importance Of Liquid Assets
The liquid asset provides financial freedom and they can also provide you money when your business needs it. Therefore, the liquid asset offers more versatility so that you can run your business properly. Moreover, liquid asset maintains a concrete value and accessibility. Let’s check other importance of liquid assets.
Liquid assets will provide you security in various unexpected events or tragedies. For example, having an emergency savings account means you have three to six months of living expenses. So, it means you have almost immediate access to money in the event of an emergency. You can also invest in money market funds and bonds because they are also considered a liquid assets. You can easily sell these assets and generate money whenever you want.
Liquid assets ensure flexibility in the form of buying power. Having liquid assets means you have immediate access to a large or small purchase. The liquid asset can act quickly to get you a good deal on everything from clothing to real estate. However, if you have a low cash reserve then it restricts the opportunity to act quickly.
You can easily allocate a percentage of your portfolio to liquid assets. If you hold your cash then it will provide resistance to the ups and downs of the stock market. Moreover, you will have a better balance for riskier investments. Having a percentage of your portfolio to liquid asset usually reduces the overall risks because liquid asset holds the value. If you keep some of your portfolios to liquid assets then you will have the option to buy stock or funds when the time is right.
Small businesses can use liquid assets as a short-term funding source. These types of sources are known as current liabilities and you can use them to fund liquid assets and pair the lower return of liquid assets thanks to the lower cost of short-term funds. As a business owner, you can allot some long-term funds to current, liquid assets and generate profits. This extra working capital also increases a company’s liquidity.
Prevent Misuse Of Funds
You can use the long-term funds as short-term funds but it is not wiser to use the short-term funds for the long-term. The short-term liquid assets might be cheaper but using them as the long-term fund can cause a big problem for your business in the future. This is because a long time is required to liquidate long-term illiquid assets so they can’t be converted to cash in the required time frame. So liquid asset prevents the misuse of short-term funds for long-term assets and it’s very important for a business. This type of misuse weakens the liquidity of a company and disrupts daily operations.
FAQs About Liquid Assets
1. Why Is Liquidity Important To The Economy?
Liquidity or liquid asset is important for the economy because you can use the liquid asset to deal with any unexpected short-term crisis. Moreover, liquid assets offer better capital gains and higher yields for a business.
2. Why Is It Important For A Business To Be Liquid?
There are many reasons a business must be liquid. Some key reasons are –
1. To make quick payment of any loans of a business
2. Meet the current demand of a certain cash amount
3. To avoid difficult situations in unexpected events or tragedy
3. What Is A Disadvantage Of Excess Liquidity?
An excess amount of liquidity has disadvantages. One of the major drawbacks of excess liquidity is businesses may find it difficult to raise capital.
4. Why Liquidity Is Important For Banks?
Liquidity is very important for banks because it determines the growth and development of the bank. Liquidity ensures proper functioning of financial markets so having low liquidity can cause bad effects on the market values of assets of a bank.
5. Is A Car A Liquid Asset?
No, the car is not a liquid asset. In fact, the car is a non-liquid asset. The reason is, the car is very difficult to sell so it will take time to convert the car into cash. Moreover, the car might lose value in the sale.
6. What Are Good Liquid Assets?
Cash money is the best liquid asset because you don’t have to take further steps to convert it. Other examples of good liquid assets are trust funds, tax refunds, court settlements, certificates of deposit (CDs), etc.
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.