What Are Net Liquid Assets?
Net liquid assets are a measure of an immediate or near-term liquidity position of a firm, calculated as liquid assets less current liabilities. Liquid assets are cash, marketable securities, and accounts receivables that can be readily converted to cash at their approximate current value.
- Net liquid assets are a measure of the near-term liquidity position of a firm, calculated as liquid assets less current liabilities.
- Liquid assets include cash, marketable securities, and accounts receivables. They are any assets that can be quickly converted into cash.
- Having a net liquid asset position signifies a company is in good health and is able to pay its short-term obligations, such as paying suppliers and paying down short-term debt.
- A net liquid asset position also demonstrates that a company can make new investments without having to take on financing.
- Having too many liquid assets, however, demonstrates an idle use of cash, whereby the money could be put to better use, such as other investments or paying out dividends.
Understanding Net Liquid Assets
The amount of net liquid assets is one of a few measures that gives a snapshot of the financial condition of a firm. Cash and marketable securities are ready to deploy, while accounts receivables could be turned into cash within a short period of time, though perhaps not completely as there is typically a small percentage of bad debt associated with aged receivables. Inventory does not qualify as a liquid asset because it cannot be readily sold without a significant discount.
Current liabilities mainly encompass accounts payable, accrued liabilities, income tax payable, and a current portion of long-term debt for the average company. Subtracting current liabilities from the above liquid assets shows the financial flexibility of a company to make a quick payment.
Advantages of Net Liquid Assets
Having a strong net liquid asset position is important for a firm because it demonstrates that a firm is able to pay off its short-term obligations, such as paying suppliers and paying off short-term debt. It also signifies that a company is able to make new investments, such as the purchase of equipment, without having to take on financing.
Companies that have a strong net liquid asset position are also better placed in times of economic downturns. They are in a position to weather the storm by relying on its liquid assets to continue paying its short-term obligations even if business is not booming.
On the other hand, a company that does not have a strong net liquid asset position and no significant revenues in an economic downturn will not be able to meet its obligations and may have to declare bankruptcy.
Having net liquid assets also makes it easier to receive financing from a bank as it demonstrates the ability of a company to pay off its loans, even in times of distress. This also results in usually receiving a better interest rate on a loan.
Though having net liquid assets is a positive position to be in, having too many liquid assets is not the most beneficial use of cash, as it could be invested and earning a return elsewhere, rather than sitting idly in a bank account. Conversely, it can also be used to pay dividends to shareholders.
There is a fine balance that a company must strike between enough liquid assets and too many liquid assets. The general rule of thumb is that if a business has six months of liquid assets to meet short-term obligations and cover operating expenses, it is in a good position financially.
Example of Net Liquid Assets
Say that XYZ Widgets, Incorporated has the following components on its balance sheet for current assets and current liabilities:
- Cash: $22.7 million
- Accounts Receivable: $29.5 million
- Inventory: $110.5 million
- Prepaid Expenses: $11.7 million
- Income Tax Receivable: $1.5 million
- Other Current Assets: $10.3 million
- Accounts Payable: $53.8 million
- Accrued Liabilities: $73.5 million
- Current Portion of Long-Term Debt: $9.5 million
- Income Tax Payable: $1.7 million
Net liquid assets as of this date would be:
Cash + Accounts Receivables - Current Liabilities =
$22.7 million + $29.5 million - $138.5 million = -$86.3 million.
The negative net liquid position of the company may be a concern, but this situation is typical for a retailer. Still, it indicates that the company is not in the best financial position, particularly if the economy takes a turn for the worse.
What Are Common Examples of Liquid Assets?
A liquid asset is an asset that can be easily and quickly converted into cash. Examples of liquid assets may include cash, cash equivalents, money market accounts, marketable securities, short-term bonds, and accounts receivable.
Why Are Net Liquid Assets Important
Net liquid assets are important because a company consistently needs cash to meet its short-term obligations. Without cash, a company can't pay its bills to vendors or wages to employees. Liquid assets are also needed in case a short-term emergency arises that requires money to be spent.
What Is the Difference Between a Liquid Asset and Illiquid Asset?
A liquid asset is an item of future economic benefit to a company that can easily be exchanged for cash. On the other hand, illiquid assets are more difficult to sell. Examples of illiquid assets would include real estate & land, vehicles, equipment & machinery, and certain over-the-counter (OTC) securities, among others.