Liquidity assets are readily available assets that companies use to finance their operating business. We show you here what this asset class includes, why it is so important and what it says about the financial situation of a company.
What is a liquidity asset? Meaning explained
A liquidity asset is an asset that can be converted into cash very quickly and easily. Cash and account balances belong to this category, as do tradable securities (e.g. shares) and treasury bills.
The following criteria can be used to assess whether an asset is a liquidity asset:
- The asset is established in a liquid market where there are very many buyers at any time
- The asset must be able to move from one owner to another very easily and securely
- The conversion of the asset into cash takes little time (less than 1 year) and the cash value is not or only minimally smaller after the conversion than before the conversion
What are some liquidity asset examples?
Some examples of liquidity asssets are:
- Cash in paper and coin form (also in foreign currencies, if not too exotic)
- Account balances
- Treasury bills and treasury notes
- Securities tradable on the stock exchange (e.g. shares, ETFs, funds, bonds)
- Accounts receiveable
What is a liquidity asset in accounting and why is it important?
Liquidity assets have a special significance for companies, because they are used to finance day-to-day business: Cash flows out of the accounts as expenditure and into the accounts as income. Companies use liquidity assets to pay their bills and make their investments.
On the balance sheet, all assets of a company are divided into long-term and short- term assets and sorted according to their liquidity. Short-term assets include liquidity assets, as these are assumed to be converted into cash in less than one year. Cash is the most liquid asset, while accounts receivable with long payment terms are the least liquid.
What is a liquidity assets formula?
There is a formula to calculate the amount of liquidity assets:
Liquidity assets = Cash + cash equivalents + marketable securities + accounts receivables
If you want to know more about the liquid situation of the company, you can compare the liquidity assets with various other values, for example:
Quick ratio = Liquidity assets / Current liabilities
Current liabilities are all financial obligations of the company that are due in one year or less (e.g. monthly loan instalments or outstanding supplier invoices).
The quick ratio indicates the company's ability to finance all of its current liabilities with its liquidity assets. The higher the quick ratio, the more cash the company has available to finance its operations.
What is a liquid asset buffer?
For banks, liquidity buffers are, for example, cash reserves at the central bank or short-term debts of a state with a good credit ranking. These buffers are used by a bank to quickly make large cash outflows if this becomes necessary.
The principle of liquidity buffers is similar for companies: cash reserves are formed (so- called reserves) that can be drawn on in an emergency. This can be the case if an unexpectedly high bill has to be paid or an unplanned investment has to be made, e.g. if a production machine breaks down and a new one has to be purchased quickly so that production does not come to a standstill.
So that a company does not have to take out a bank loan in such a case, it draws on its cash reserves. The liquidity buffer is then replenished over time by setting aside a share of the revenues.
How high the liquidity buffer of a company is, is determined by those responsible. There are no legal requirements for this. However, it is recommended to have a liquidity buffer that is sufficient for at least six months to cover the running costs if the income would be zero at the same time.