Definition: Liquid assets are resources used by all market participants that can be easily converted into cash without losing their value. Typical examples are banknotes, checking accounts, and government bonds.
What Does Liquid Assets Mean?
What is the definition of liquid assets? A liquid asset enables a firm or an individual to have access to cash immediately. Cash is by definition liquid, which explains why the forex market is widely considered as the most liquid exchange market globally with more than 5 trillion of dollars being exchanged on a daily basis.
Moreover, liquid assets have a relatively stable market price and do not fluctuate sharply, ceteris paribus. On an individual basis, a checking or a savings account is a liquid asset because it provides access to cash instantly with a money withdrawal. Also, in some countries, gold and silver are also considered sources of liquidity.
Let’s look at an example.
Example
George holds 3,000 shares of different companies that operate in the technology and the construction sector. He has a well-diversified portfolio with an asset allocation of 35% equities, 55% government bonds and 10% real estate, and he can have access to the value of his assets as soon as he decides to sell them.
A month ago, George was in need for cash for his daughter’s school expenses. Because the market was rallying for a few days, George saw a potential to sell some of his stocks and realize a large profit. So, he sold 250 shares of a construction company for $145 while he had bought them for $100. So, he made an instant profit of 250 x $45 = $11,250 minus fees and commissions, and he covered his need for cash.
Contrast this with George’s real estate investment. He would not be able to instantly convert his real estate into cash because it takes time to find the right buyer, agree on a price, and close the transaction. Real estate is not as liquid as securities are.
Generally, anything that can be easily sold and converted into currency is considered liquid. For example, in some high turning industries inventory is considered liquid because it is sold so readily. Some other examples include: accounts receivable, treasury bills, and cash equivalents.
Summary Definition
Define Liquid Assets: A liquid asset means a resource that is readily an easily converted into cash or currency.
