Difference Between Liquid Assets and Non-Liquid Assets
A fundamental concept in Commerce, liquid assets play a key role in understanding a business's ability to meet short-term obligations. Liquid assets refer to resources that can be easily and quickly converted into cash with minimal impact on their value. These assets are important while analyzing the financial strength and flexibility of any company or organization.
What Is a Liquid Asset?
A liquid asset is any asset that can be readily exchanged for cash in a very short time. The primary feature is high liquidity, meaning there exists an active market with many buyers and sellers, allowing for quick conversion at a predictable value. Generally, these assets are shown under the current assets section on a company's balance sheet.
Examples include cash, cash equivalents, money market accounts, short-term bonds, and marketable securities. These resources are important for routine payments, emergencies, or meeting immediate business expenses.
Key Principles and Examples of Liquid Assets
All liquid assets are a part of current assets but not every current asset is highly liquid. Long-term assets, like property or machinery, are not considered liquid since they cannot be sold quickly without potential loss in value or a lengthy selling process.
Below is a table to help differentiate between some common asset types:
| Asset Type | Example | Liquid Asset? |
|---|---|---|
| Cash | Bank balance, physical cash | Yes |
| Money Market Accounts | Short-term deposits, no lock-in | Yes |
| Marketable Securities | Publicly traded stocks, bonds | Yes |
| Accounts Receivable | Customer dues expected soon | Yes |
| Inventory | Unsold goods | No |
| Property/Office Building | Land, real estate | No |
How to Identify and Analyze Liquid Assets
Liquid assets generally have active markets and can be quickly bought or sold at transparent prices. For instance, money market holdings have no holding restrictions and can be exchanged in the open market easily. This makes them prime examples of liquid assets.
To analyze a company's liquidity, two main financial ratios are used:
- Quick Ratio (Acid-Test Ratio): Shows the proportion of liquid assets available to cover current liabilities.
- Current Ratio: Compares all current assets (including inventory) to current liabilities.
| Ratio | Formula | What It Indicates |
|---|---|---|
| Quick Ratio | (Cash + Marketable Securities + Receivables) / Current Liabilities | Short-term liquidity without inventory |
| Current Ratio | Current Assets / Current Liabilities | Overall short-term coverage |
Examples and Stepwise Approach
Suppose a company holds these assets and liabilities:
- Cash: ₹50,000
- Marketable Securities: ₹30,000
- Accounts Receivable: ₹20,000
- Inventory: ₹15,000
- Current Liabilities: ₹60,000
Step 1: Identify liquid assets.
Cash + Marketable Securities + Accounts Receivable = ₹50,000 + ₹30,000 + ₹20,000 = ₹1,00,000
Step 2: Use the quick ratio for analysis.
Quick Ratio = Liquid Assets / Current Liabilities = ₹1,00,000 / ₹60,000 = 1.67
A quick ratio above 1 indicates the company can cover its short-term obligations using its most liquid resources.
Liquid vs. Illiquid (Non-Liquid) Assets
While liquid assets can be changed to cash easily, illiquid assets are difficult to convert quickly. For example, an office building may take months to sell, while publicly listed shares can be sold online almost instantly.
| Criteria | Liquid Assets | Illiquid Assets |
|---|---|---|
| Convertibility | Quick, easy, minimal loss | Slow, possible value loss |
| Examples | Cash, stocks, money market | Land, property, equipment |
| Typical Use | To pay immediate obligations | Long-term investment/resources |
Applications and Importance
Having adequate liquid assets allows a company to pay suppliers, cover salaries, and handle emergencies. Lack of sufficient liquid resources may hamper business payments and create financial risks. Businesses consistently monitor liquidity to maintain solvency and financial flexibility.
Application in Commerce Analysis
Accurately identifying and categorizing assets as liquid or non-liquid is essential in preparing balance sheets and for calculations relevant to accounting ratios. This aids better decision-making and signals a firm's ability to withstand short-term shocks.
For more understanding on related financial topics, visit Vedantu Commerce.
Next Steps for Practice and Learning
To reinforce your understanding, try categorizing various assets in a sample balance sheet or solve numerical questions using the given quick ratio and current ratio formulas. Consistent practice will improve your capability to analyze business solvency and financial health.
Explore more Commerce concepts and deepen your learning through topic-wise notes and quizzes at Vedantu Commerce.
FAQs on What Are Liquid Assets? Formula, Meaning & Examples
1. What is a liquid asset?
A liquid asset is an asset that can be easily and quickly converted into cash without significant loss in value. Common examples include cash, bank balances, marketable securities, and accounts receivable. These assets are important for businesses to meet short-term obligations.
2. What are some examples of liquid assets?
Typical examples of liquid assets include:
• Physical cash
• Bank account balances
• Marketable securities such as shares and bonds
• Money market instruments
• Trade receivables (debtors or accounts receivable)
3. Is a car a liquid asset?
No, a car is generally not considered a liquid asset. Vehicles are classified as non-liquid (illiquid) assets because they require time to sell and may not convert to cash quickly at their book value. Only highly marketable assets are treated as liquid assets in accounting formulas.
4. What is the formula for liquid assets?
The formula for calculating liquid assets is:
Liquid Assets = Current Assets – (Inventory + Prepaid Expenses)
Alternatively, Liquid Assets can also be calculated by summing up: Cash + Marketable Securities + Accounts Receivable.
5. Are inventory and prepaid expenses included in liquid assets?
No, both inventory and prepaid expenses are excluded from liquid assets. These items cannot be quickly converted into cash and are not included when calculating the quick or liquid ratio.
6. What is the difference between liquid assets and current assets?
Liquid assets are a subset of current assets. While current assets include all resources expected to be converted into cash within one year (such as cash, inventories, receivables, and prepaid expenses), liquid assets exclude inventory and prepaid expenses because these are not readily convertible to cash without delay or loss.
7. Why are liquid assets important for businesses?
Liquid assets are essential for ensuring a business can meet its short-term liabilities and operational needs. They provide financial flexibility, support solvency, and are used in key financial ratios like the quick ratio to assess a company's immediate financial health.
8. How do you calculate the liquid ratio (acid-test ratio)?
The liquid (acid-test) ratio is calculated as:
Liquid Ratio = Liquid Assets ÷ Current Liabilities
This ratio is a key indicator of a company's ability to pay its short-term debts using its most liquid assets.
9. Are stocks and bonds considered liquid assets?
Yes, publicly traded stocks and bonds (marketable securities) are generally considered liquid assets. These securities can be sold quickly on the stock market and converted into cash, making them suitable for inclusion in liquidity calculations.
10. Can a house be classified as a liquid asset?
No, a house is not regarded as a liquid asset. Real estate is classified as a fixed or illiquid asset because it usually requires significant time and effort to sell. The value may fluctuate and liquidity is low compared to cash or marketable securities.
11. What is the difference between liquid assets and illiquid assets?
Liquid assets can be quickly and easily converted to cash at minimal loss in value (e.g., cash, bank balances, marketable securities). Illiquid assets are difficult to sell, may take significant time to convert, and may lose value during the process (e.g., property, machinery, vehicles).
12. Which assets are typically excluded from the calculation of liquid assets?
The following assets are typically excluded from liquid assets:
• Inventory (stocks of goods)
• Prepaid expenses (advance payments for services)
• Fixed assets (land, machinery, buildings)
• Long-term investments
These are excluded because they are not quickly convertible into cash.
