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What Is a Liquid Asset?

by gbaf

Simply put, liquid asset refers to the level to which an asset is readily liquidated or purchased in the market upon its sale at a specified price reflecting its current intrinsic value. Money is universally recognized as the most liquid asset, as it is easily and rapidly convertible into other liquid assets. However, in practical terms money can only be readily liquidated when it is needed to make a profit. Hence, money is the best liquid asset.

A high-liquidity business is one which has a high liquid assets, low cost of financing, low average selling prices, and a high cash ratio. The high cash ratio is determined by comparing current assets, current liabilities, and expected future income from existing assets, liabilities, and profits from new assets with available cash. The low cost of financing is determined by controlling interest rates, and having access to credit. A high liquidity business is also characterized by a high liquidity profit motive, low costs of financing, and consistent cash flow. Ideally, all these characteristics would be expected of all businesses. But realistically, they are not always realized, especially in volatile market conditions.

Liquidity is not just a factor of interest, but should also be considered as a fundamental economic principle. In a liquidity crisis, the need to liquidate stock, invest in short-term assets, or reduce long-term liabilities raises questions regarding the solvency of the company. A liquid-market analysis would be needed to determine the solvency of the company.

In practical terms, however, it is easier to calculate the liquid-market-attributes of a company based on its historical and current assets, liabilities, and profits. The liquid asset’s table in the balance sheet is basically the sum of all current assets, including short-term and long-term investments. The value of a company’s liquid assets represents the total current worth of the company. The current value of the company’s liquid assets is equivalent to the current market value of all of the individual shares of the company.

This is called the net worth, or LAM. The current assets, liabilities, and earnings ratios are then evaluated using the well known ratios, such as the beta, alpha, and gamma formulas. These ratios evaluate current assets, liabilities, and earnings at the current market value, which is equal to the current LAM. The beta, alpha, and gamma ratios are used to evaluate the efficiency of the company in producing cash and in generating surplus cash.

The other ratios are necessary only for investors to understand the health of the company. The beta and alpha ratios to evaluate the company’s short-term investments (such as loans and equipment) and its long-term investments (such as accounts receivable and inventory). The short-term investments are known as liquidity capital and the long-term investments as capital inventory. The short-term investments are negatively affected by stock price fluctuations.

The short-term investments are negatively affected by stock price fluctuations due to general economic conditions. This is also why many analysts recommend a monthly cash flow projection for their clients. Current assets, liabilities, and earnings ratio can not represent the health of a company, unless the analyst can quantify it and then provide information on a projected basis, over a period of time.

A good accounting liquidity ratio is necessary in order for an investor to understand the health of the company. Investors need to be aware of the liquidity position of a company. The illiquidity calculation involves the calculation of the ratio of current assets to current liabilities and the duration that it would take to liquidate all of the company’s liquid assets if sold. This calculation uses the alpha, beta, and gamma factors in order to identify the liquidity risk. The calculation is commonly referred to as the P/L ratio.

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