A liquid asset is anything that can be transformed into cash quickly in a short amount of time and with no loss in value. Examples of liquid assets include cash, inventory, accounts receivable, marketable securities, tax refunds, and cash alternatives. Cash is the most liquid asset in the world.
A liquid asset is calculated by determining the total liquid assets, adding up the assets, then subtracting the total current liabilities including, short-term debt and obligations.
The advantages of liquid assets include easy conversion to cash, financial flexibility, price safety and stability, peace of mind, and expanded investment opportunities.
The disadvantages of liquid assets include lower returns, missed opportunities, inflation risk, exposure to market volatility, and the temptation for impulse purchases.
What is a Liquid Asset?
A liquid asset is any asset that can be converted quickly and easily to cash with minimal impact on its value. Liquid assets have an active and well-established market with many buyers and sellers, ensuring fast and secure transactions. Liquid assets hold their value well, meaning they can be sold near the actual market value so sellers don’t take a loss.
Cash is the most liquid asset in finance because it’s the most accessible and has the highest demand. Individuals, businesses, and banks hold liquid assets like cash because of the flexibility and security that liquid assets offer, enabling them to cover emergency expenses and meet their short-term obligations.
The major currency pairs like EUR/USD, USD/JPY, and GBP/USD are examples of liquid assets in Forex. A liquid currency pair experiences high trade volume because buyers and sellers are always available. Traders and investors trading liquid markets enjoy tight spreads and market depth which ensure low transaction costs for large trade positions.
Liquid asset is among the most used forex trading terms because it refers to currency pairs with low volatility due to their widespread use in international trade and investment.
What are Liquid Assets Examples?
Examples of liquid assets are listed below.
- Cash
- Inventory
- Accounts Receivable
- Marketable Securities
- Tax Refunds
- Cash Alternatives
Liquid assets differ from non-liquid assets, which are assets that are difficult and take time to convert into cash without incurring a substantial loss in value. Examples of illiquid assets include real estate, art pieces, jewelry, antiques, cars, private company interests and private equity, over-the-counter stocks, employee stock options, and some types of debt instruments and hedge funds.
1. Cash
Cash is the physical currency consisting of paper bills and coins, and money in checking accounts or savings account balances. Cash is the most liquid asset because it’s readily accessible and universally accepted as a medium of transaction exchange.
Cash doesn’t incur transaction costs or require additional conversion processes for users to make purchases, pay bills, or settle debts. Individuals, traders, and businesses prefer cash because it is backed by the government, which guarantees its stability. There’s never a risk of losing value during conversion or sales because cash doesn’t fluctuate in value.
2. Inventory
Inventory is the goods and raw materials that businesses hold for their day-to-day operations. Businesses keep inventories to ensure that they can meet customer demands without unnecessary holding costs. A company’s inventory is typically categorized as either raw materials, work-in-progress (WIP), or finished goods that are ready for sale.
Inventory is a liquid asset because it’s easily convertible to cash when businesses sell them. The market value for most inventory is easy to determine through market research. Inventory often has a wide range of customers including retailers, end-consumers, and wholesalers.
Inventory isn’t always as liquid as cash or other highly liquid assets. The liquidity of an inventory depends on the product type, market demand, and economic conditions.
Highly perishable products and seasonal goods such as flowers or food have a limited shelf-life, making them less liquid. High demand for some inventory items increases the inventory’s liquidity since goods are selling quicker and at favorable prices. Inventory is typically considered a less liquid asset during periods of economic downturns when it’s harder to convert items to cash.
3. Accounts Receivable
Accounts receivable (AR) refers to the money owed to a business by its customers for goods or services already delivered or consumed but not yet paid for. Accounts receivable represents a future cash inflow that’s recorded on the company’s balance sheet since customers are obligated to pay their outstanding invoices.
AR is considered a liquid asset because the debt often has a short-term settlement period, after which the customer has to convert the accounts receivable to cash. The payment terms for AR usually range between 30 – 90 days, but can sometimes extend to one calendar year.
The liquidity of accounts receivable varies depending on the creditworthiness of customers and the credit terms. Customers with strong track records of timely debt payment have a high creditworthy score and increase AR liquidity. Short and strict payment terms result in faster and effective credit collection, enhancing AR liquidity. Long-term account receivables increase the chances of default, making AR less-liquid.
Accounts receivable carry the risk of bad debt if the customers fail to pay their outstanding balances. Other customers may delay their payments past the agreed timeline, and others may trigger disputes or disagreements regarding the amounts owed or the quality of goods or services offered. Payment delays and disputes result in reduced AR liquidity since the company may not collect the full amount owed.
The opposite of accounts receivable (AR) is accounts payable (AP), which is the money a business owes its vendors for goods or services already delivered or consumed.
Accounts receivable is more liquid than inventory and other fixed assets but is less liquid than marketable securities and cash.
4. Marketable Securities
Marketable securities refer to financial instruments that can be bought or sold easily on a public exchange such as a stock exchange, or in an active secondary market like the bond market. Examples of marketable securities include stocks, bonds, Treasury Bills (T-Bills), money market instruments, commercial paper, and exchange traded funds (ETFs).
Marketable securities are usually highly liquid as they are traded quickly on exchanges or over-the-counter (OTC) markets, ensuring a ready market for the instruments.
Most marketable securities like stocks, bonds, and index funds, have a constant flow of buying and selling activity and are easily transferable on exchanges, making it easier for sellers to find buyers and complete transactions.
Marketable securities have short-term maturities, often less than a year, and their prices are available to the public for transparency. Companies include marketable securities on their balance sheets as current assets that help them generate returns and ensure they meet their short-term financial obligations.
5. Tax Refunds
Tax refunds are reimbursements from the government to taxpayers who overpaid their taxes in a given period. Tax refunds arise when an individual or company overestimates their tax payments or when they’re eligible for certain tax deductions and credits. A tax refund is considered a liquid asset because it represents money expected to be received in the near future.
Tax refunds are low-risk because they’re backed by the government and have high certainty once approved, making them a reliable source of cash. Taxpayers often receive their tax refunds within weeks to a couple months after filing their tax return.
A tax refund, unlike other assets, isn’t affected by market conditions and price fluctuations, making it more dependable. Taxpayers can’t rely on tax refunds because they’re not available every year.
6. Cash Alternatives
Cash alternatives are short-term and highly liquid financial instruments that offer higher yields than simply holding in a bank savings account. Cash alternatives are easily convertible to cash while persevering the value of money, making them very liquid assets. Examples of cash alternatives include Money Market Funds, Treasury Bills (T-Bills), Certificates of Deposit (CDs), Repurchase Agreements (Repos), and short-term bonds.
Cash alternatives offer businesses and investors short-term maturities ranging from a few days to months, with little to no risk of price fluctuation. The convenience of short-term maturities attracts more market players who prefer to have control and predictability in their investments, contributing to asset liquidity.
How are Liquid Assets calculated?
Liquid assets are calculated by identifying and adding up an individual’s or business’s total liquid assets and subtracting the total current liabilities. Liquid assets include cash on hand, accounts receivable, checking and savings bank account balance, marketable securities, and cash equivalents. Current liabilities include accounts payable, short-term debt, accrued expenses, income taxes payable, and the current portions of long-term debt.
The formula for calculating an organization’s net liquid assets is given by; Net Liquid Assets = Liquid Assets – Current Liabilities.
For instance, a company with $4 million in cash, $2 million in marketable securities, and $3 million in current liabilities has $3 million in net liquid assets ($4 million + $2 million – $3 million = $3 million).
Cash is the most liquid form of money in finance. Businesses and countries with more cash and cash equivalents tend to have more liquid assets and better net liquid assets ratios.
An institution’s liquid asset ratio is obtained by dividing the sum of its most liquid assets by the sum of accounts payable and other current liabilities. For instance, data from CEIC DATA shows that Germany’s liquid asset ratio as of March 2023 was at 17.9% while the United States had a liquid asset ratio of 14.7% as of May 2024. Positive liquid asset ratios (17.9% and 14.7%) indicate that Germany and the U.S. have more liquid assets than current liabilities (with Germany having more liquid assets than U.S).
A negative net liquid ratio indicates negative financial health for a business or country. For example, CEIC DATA indicates that Singapore had a negative liquid asset ratio of 134.3% as of December 2019, meaning that Singapore had more current liabilities than liquid assets.
Economies or businesses with negative liquid assets often experience difficulties fulfilling their short-term obligations and securing financing from banks and lenders.
Investors and financial lenders use financial metrics like the current ratio, quick ratio, and cash ratio to gain insights into a company’s liquidity. The current ratio measures a company’s ability to pay off its short-term liabilities with its short-term assets. Quick ratio (Acid-test ratio) is a refined version of the current ratio that excludes inventory from the calculations because inventory liquidity varies according to market conditions. Cash ratio measures a company’s ability to pay off short-term liabilities with only cash and cash equivalents.
Financial analysts and investors incorporate advanced metrics when tracking liquid investments or measuring an institution’s liquidity position. Metrics like the Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR), and Operating Cash Flow ratio (OCF), among others, consider other aspects of the ‘liquidity definition’ such as management, operational efficiency, and cash flow stability, which are critical for making informed financial decisions.
How does Liquid Assets work in Trading?
Liquid assets in trading are assets that are quickly convertible to cash at a fair price without losing value. Liquid assets in trading include stocks, Forex, bonds, options, and commodity futures. A liquid asset is characterized by high trading volume, tight bid-ask spreads, and quick trade settlements. Liquid assets provide multiple trading opportunities for traders and investors, making them very attractive.
The Forex market is the most liquid globally, trading nearly $7.75 trillion every day. Major Forex currency pairs like EUR/USD are highly liquid because many buyers and sellers are willing to actively trade the asset, making it easier to find counterparties for each trade. The currency pairs have tight bid-ask spreads and quick executions because liquid markets make it easier for brokers to fill orders at the best price levels.
Forex trading, which is the buying and selling of currency pairs for profit, relies on liquid currencies to provide entry and exit opportunities for traders and investors. Forex trading market participants often use margin and leverage when trading liquid assets to maximize their profits. Trading liquid assets makes it easier to manage risks on margin accounts, ensuring traders can cover their potential losses and maintain positions in volatile market conditions.
Trading illiquid assets is usually more expensive since traders incur wider spreads and higher broker commissions and fees. Traders and investors tend to diversify when trading illiquid assets to increase their returns and hedge positions against losses.
Diversification in financial markets results in increased trading activity and helps increase the liquidity of assets. A study by Lubos Pastor et. al. (2017) titled ‘Portfolio Liquidity And Diversification: Theory And Evidence’ concluded that fund portfolios have become more liquid over time, mostly as a result of becoming more diversified. The study also showed that funds holding less liquid portfolios incur higher trading expenses and tend to diversify more, which helps them boost their overall portfolio liquidity.
The rise in Fintech (financial technology) and digital trading platforms contributes to the increasing liquidity in most assets. Technology has made real-time trading easy through automated algorithmic trading systems, enabling traders to take more trades and ensuring markets remain liquid and responsive.
Fintech platforms have reduced the barrier to entry for traders, granting more people access to the markets, leading to increased market liquidity.
Can Liquid Assets be used on Forex Broker Platforms?
Yes, liquid assets can be used on Forex broker platforms to facilitate transaction processes like funding accounts, margin trading, and trade execution. Forex brokers allow traders to complete cash deposits through electronic bank transfers or debit/credit cards. Some brokers may allow deposits from cash equivalent assets such as money market accounts or short-term Certificates of Deposit (CDs), although this is rare.
Liquid assets enable Forex trading brokers to facilitate faster buying and selling of currency pairs, ensuring efficient trading. Leverage traders have to deposit sufficient liquid assets like cash on their broker platforms to meet the margin requirements for leveraged trading.
Brokers allow traders to use liquid assets (like buying currencies) on their platforms to implement hedging strategies against potential losses in other positions.
What are the Benefits of Liquid Assets?
The benefits of liquid assets are listed below.
- Easy conversion to cash: Liquid assets can be quickly converted to cash without significant loss of value, providing liquidity for emergencies or planned expenses.
- Financial flexibility: Liquid assets provide businesses and individual traders with the flexibility to adjust their operations and respond to changes in market conditions.
- Price safety and stability: Liquid assets are usually low-risk investments, providing a stable store of value and making them suitable for preserving capital and maintaining financial stability.
- Risk management: Liquid assets provide a buffer against market volatility by allowing market participants to sell liquid assets quickly to reduce the exposure of their open participants.
- Investment opportunities: Liquid assets allow investors to capitalize on opportunities that require quick cash, such as buying undervalued assets or participating in time-sensitive investments.
- Peace of mind: Liquid assets reduce financial stress for businesses and individuals as they ensure that financial obligations can be met without difficulty.
- Diversification: Traders use liquid assets to diversify portfolios, reducing dependence on a single asset class or market and balancing more volatile investments with stable, easily accessible funds.
What are the Downsides of Liquid Assets?
The downsides of liquid assets are listed below.
- Low returns: Buying and selling liquid assets comes at the cost of lower potential returns compared to higher-risk investments like real-estate.
- Opportunity cost: Investing heavily in liquid assets means potentially missing out on other higher-returns investments or growth opportunities.
- Market volatility: Fluctuating prices due to changes in interest rates means liquid assets are risky investments, and traders can lose money when prices fluctuate.
- Inflation risk: Holding on to liquid assets exposes traders to inflation, where the purchasing power of the funds decreases over time.
- Psychological risk: Accessing liquid assets is easy, and this may tempt individuals to make impulsive purchases or expenses, undermining long-term financial goals.
- High trading costs: Liquidating some assets quickly involves transaction fees or penalties, and taxes, reducing the effective liquidity of the investment.
