Understanding Liquid Assets: Definition, Examples, and Importance

Anything of financial value to a business or individual is considered an asset. The value of liquid assets is incomparable, no matter how many valuable assets you have. A business can generate billions in revenue but needs liquidity to stay afloat in a financial emergency. In this blog, we will talk about what liquid assets are. Discover what assets are considered liquid and why liquid assets are important for individuals and businesses to have in their portfolios.

Content

• What are Liquid Assets?
• Definition of Liquidity
• Why Is Liquidity Important For Businesses Or Individuals?
• What Do You Use Liquid Assets For?
• Types of Liquid Assets
• Characteristics of Liquid Assets
• What Are Illiquid Assets?

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What are Liquid Assets?

Liquid assets are goods that, without delay, can be converted into money or consumed in a normal operating cycle. An asset’s liquidity value largely depends on its owner’s expectations of its market value.

Definition of Liquidity

Liquidity is the ability of an asset to be turned into cash quickly and without losing value. Therefore, the greater the liquidity, the faster an asset can be converted into cash without affecting its value.

On the contrary, the less liquidity, the longer the delay and/or more loss of value an asset has to be converted into cash. For example, the shares of a company are liquid assets because they can be sold quickly at a suitable value.

On the other hand, a house is an asset with little liquidity (illiquid) since its process and closing of sale are much greater. Rarely can a property be sold quickly at a good price. And those who want a quick sale must usually do so at the sacrifice of a significant percentage of their value. 

Why is Liquidity Important for Businesses or Individuals?

Liquidity is the level of accessibility to your investment and determines how long it will take you to be able to dispose of these resources. The conversion process differs from asset to asset. For example, in the case of a retirement fund, you will need the necessary paperwork to liquidate the funds, which can take some time.

Provision for Cash Reserve

Irrespective of your investment, you must have a portion of your money available for instant access. In this way, thanks to the conversion costs, you can keep the value of your funds intact. Any cash you have is reserved for emergencies and needs to be replenished immediately. While there is no magic formula to calculate how much to have, it is suggested to have at least three months of our take-home pay in cash.

A Balance of Liquid and Illiquid Assets

It is recommended to have at least 60% of the assets invested in liquid assets: stocks, bonds and mutual funds. These are funds that can be collected monthly. In the case of a publicly traded investment option, you will need to ensure that you invest with a long-term plan to avoid any price impact.

What Do You Use Liquid Assets For?

They can be used for all kinds of expenses. Your business bank statement shows how much cash is immediately available to make a payment. For example, to pay an invoice to a supplier or pay salaries. For example, the checking account allows you to disburse if the balance is positive.

Types of Liquid Assets

Following are some of the most important types of liquid assets.

Cash

Cash is the most liquid asset of all and is the yardstick used to measure liquidity. Here comes all your money from checking, savings and money market accounts for its ease of accessing cash.

Also read: Instruments of Money Market: Meaning and Types

Deposit Certificates

Although CDs allow you to save money and make it grow, it is a type of liquid asset you can only use at a previously established time, called a term. Due to their long duration, in addition to the penalties you may incur for early withdrawals, certificates of deposit are slightly less liquid.

Shares And Marketable Securities

Marketable securities, such as stocks, are another type of cash-equivalent liquid asset. They are financial instruments that can be easily bought or sold. It is also considered a liquid medium because its value is determined by market activity when you need the cash.

Investment Funds

While mutual funds can be easily sold for cash, the value of these assets is sensitive to any market downturn, limiting the amount of cash you can access.

Short-Term Government Bonds

Treasury bonds are also a form of cash equivalent liquid asset. They are easy to buy and sell without significant price changes. They pay interest regularly, so you’ll often know how much cash to expect once the bond matures.

Treasury Bills

These are short-term debt securities issued by certain governments like the US government and can be easily bought and sold in the market.

Commercial Papers

Commercial Papers are unsecured promissory notes issued by companies and can be easily traded.

Money Market Funds

Money market funds are mutual funds that invest in short-term debt securities and can be easily bought and sold in the market.

Characteristics of Liquid Assets

The following are the common characteristics of liquid assets:

1. Readily Convertible: Liquid assets can be quickly and easily converted into cash without significant loss of value.
2. High Market Demand: They have a robust market demand, making selling them at or near their market price simple.
3. Low Price Fluctuation: Liquid assets typically experience minimal price fluctuations in the short term.
4. Widely Accepted: They are widely accepted as a means of payment or exchange in financial transactions.
5. Minimal Transaction Costs: Transaction costs associated with buying or selling liquid assets are usually low.
6. High Marketability: Liquid assets are highly marketable, meaning they can be sold swiftly without much effort.
7. Frequently Traded: These assets are actively traded in financial markets regularly.
8. Stable Value: They maintain their value reasonably well over time, ensuring reliability.
9. Easily Accessible: Investors can access liquid assets quickly whenever needed.

Overall, the characteristics of liquid assets make them an important part of an individual’s financial portfolio or a business’s balance sheet. They offer quick access to cash, stability, and safety, making them essential to financial planning and management.

What Are Illiquid Assets?

Illiquid assets, also called illiquid assets, cannot be quickly converted into cash. Most illiquid assets must be sold to their value, which involves a transfer of ownership. This ownership transfer process can take months or years, as the right buyer needs to be found and, if sold quickly, often hurts their value. The most common examples of illiquid assets are real estate, vehicles, art, and collectables. 

Let’s take real estate investments as an example. They are considered illiquid since their conversion into legal tender is normally lengthy if they are to be sold without incurring losses relative to their market value. Accepting the first offers on a property may not be the best deal. Hence it may require some time to close that deal. Contract negotiations could take several months and require negotiation time to reach an amount that matches the property’s actual value.

Key Takeaways

• Liquid assets can be easily, safely and quickly exchanged for legal tender without significantly affecting their value.
• Illiquid assets cannot be quickly converted to cash. It takes time to shift their ownership when sold.
• Liquid assets are important for individuals and businesses to maintain financial flexibility and ensure quick access to funds.
• An asset’s liquidity level can impact its value and the level of risk associated with it.