The immediate liquidity position of a company
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What are Net Liquid Assets?
Net liquid assets is a term used to define the immediate liquidity position of a company. It is calculated as the difference between liquid assets and current liabilities. Examples of liquid assets include cash, money market assets, stocks, accounts receivable, marketable securities, or any assets that can be quickly converted into cash.
Net liquid assets can be used to assess the financial condition of a company. If a company owns positive net liquid assets, it means it is in a comfortable position to make any payments in the near-term or if it can undertake any investment activity without any financing support.
Certain assets do not fall in the definition of liquid assets, even though they are current assets. An example is inventory. Although it can be sold to generate cash, it is very probable that the inventory sold immediately would be sold at a discount.
Other current assets, such as prepaid expenses and income tax receivables, cannot be sold for cash, which is why they are not considered liquid assets.
When looking at current liabilities, we can categorize them as volatile or stable. In most calculations of net liquid assets, volatile liabilities are excluded. Volatile liabilities include funds that are unstable and can disappear from a company’s balance sheet overnight. An example of a volatile liability on a bank’s balance sheet is uninsured borrowings.
Summary
- Net liquid assets is a term used to define the immediate liquidity position of a company, and it is calculated as the difference between liquid assets and current liabilities.
- Asset liquidity is very crucial for all types of businesses, and it helps indicate how comfortable a company is if it faces an emergency or unusual situation.
- Certain assets do not fall in the definition of liquid assets, even though they are current assets.
Importance of Liquid Assets
Asset liquidity is very crucial for all types of businesses, and it helps indicate how comfortable a company is if it faces an emergency or unusual situation. Consider a situation where there is an economic crisis, and a company is heavily indebted without any liquid assets. The immediate effect (if the company is not able to raise additional funds) would be that it would declare bankruptcy.
It is also true that the more liquid assets a company owns, the better chances are that it gets a loan and at favorable rates. Most financial institutions ask companies to post assets as collateral, and owning liquid assets shows that in the case of solvency, the bank loan can be repaid.
Liquid assets are also an indicator of whether a company is putting its assets to good use. If a company has excessive idle cash lying around in its bank account, it can be said that it is not making good use of its liquid assets. The cash can be used for investments or paying dividends to shareholders.
However, the biggest dilemma is to maintain the ideal balance between having adequate financial security (in terms of liquid assets) and not having too much idle cash. Most companies and experts suggest having a buffer of at least six months of expenses in liquid assets, which covers operating costs and also accounts for any emergency funds that may be required during the period.
Example of Net Liquid Assets Calculation
The following is a numerical example of the calculation of net liquid assets. Figure 2 is an excerpt from the balance sheet of Company XYZ, which shows the various types of assets and liabilities of the company. The components of the balance sheet that are used to calculate net liquid assets are highlighted in grey.
Figure 3 shows the actual calculation of net liquid assets for Company XYZ. Based on the figures, the company shows a net liquid position of +2 million, indicating that it is in a fairly comfortable position to meet its short-term obligations.
More Resources
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