What are liquid assets?
Liquid assets are either cash or other current assets that can (in principle) be turned into cash readily.
Among current assets in addition to cash, inventories, accounts receivable and other short term receivables are considered somewhat liquid. The Balance sheet entries for these assets enter the calculation of liquidity metrics such as Working capital and the Current ratio.
It is a priority everywhere that management keeps close watch on the current availability and performance (turnover) of each liquid asset category:
- The timing and management of cash flow is critical for meeting obligations and needs: Paying employees, paying interest on loans or bonds, or investing in new product development or an infrastructure upgrade, for instance.
- The inventory activity metrics Inventory turns and Days sales in inventory are watched closely, so as to avoid excessive inventory carrying costs while maintaining an ability to meet customer demand for products at all times.
- The accounts receivable acttivity metrics Accounts receivable turnover and Average collection period (or, equivalently, Days inventory outstanding DIO)are watched closely, to ensure that accounts receivables do not turn into doubtful accounts or bad debt expense.
- Moreover, a shortage of liquid assets (as indicated by low scores on liquidity metrics Working capital, current ratio, and acid-test ratio) is a signal that a company may not be able to pay short term creditor obligations on time, and may have trouble meeting payroll or investing in activities necessary for survival and growth such as marketing or research and development.