Net Liquid Assets
A company's immediate or near-term liquidity position
A company's immediate or near-term liquidity position can be measured by its net liquid assets (NLA), which can be computed by subtracting its current liabilities from its liquid assets.
Cash on hand, marketable securities, and customer receivables are examples of liquid assets. These assets are readily convertible into cash at a value close to their current market price.
The level of a company's net liquid assets is one metric that can be used to evaluate its financial health.
Suppose a company has positive NLAs. In that case, it indicates that the company is in a position where it can easily make any payments that are due shortly or if it can engage in any investment activity without the need for any additional financing support.
Even though they are considered current assets, some assets do not meet the criteria for being classified as liquid assets.
Consider the case of inventory. Even though it can be sold to generate cash, there is a significant possibility that any merchandise sold right away will be done at a loss.
Other current assets, such as prepaid expenses and income tax receivables, are not considered liquid assets because they cannot be sold for cash and, therefore, cannot be converted into cash.
When considering current liabilities, we can classify them as either volatile or stable depending on the circumstances. Therefore, volatile liabilities are excluded in most of the calculations.
Included in the category of volatile liabilities are funds that are precarious and have the potential to vanish from a company's balance sheet overnight. For example, uninsured borrowings illustrate the risky weakness of a bank's balance sheet.
The following are some examples of assets that might be deemed liquid and would fit into the category:
- The term "cash" refers to any bills you might have in your wallet at any particular time. Therefore, cash can be used at any time.
- This refers to any of the cash that is now available in either your checking or savings accounts. It does not matter which version the money is in.
- This includes any funds saved in mobile payment services such as Venmo or PayPal accounts. "Mobile wallets" are another account name used to make mobile payments.
- A money market account is a type of savings account that can be held with a financial institution (such as a bank or credit union) and typically earns a greater interest rate than standard savings accounts.
- Bonds, certificates of deposit, and stocks are the three types of investments most frequently included under this category.
The concept of liquid unrestricted net assets is associated with not-for-profit organizations rather than commercial enterprises that operate for financial gain. Donations made with no conditions are counted toward an organization's available net assets.
In other words, these funds are not set aside for a particular purpose, nor are they subject to any restrictions imposed by the government.
A nonprofit organization can determine liquid unrestricted net assets by deducting liabilities from the organization's available net assets.
A solid net liquid asset position is essential for a company because it demonstrates that it can meet its short-term obligations, such as making payments to its suppliers and repaying its short-term debt.
This makes having a solid NLA position important for a company. It also indicates that a company can make new investments, such as purchasing new machinery, without resorting to additional financing sources.
When the economy is in a downturn, businesses with a solid net liquid asset position are also in a better place than those without.
Even if the business is slow, it can weather the storm because it can rely on its liquid assets to continue paying its short-term obligations. This puts them in a position where they can endure the storm.
On the other hand, a business that is not in a strong position in terms of its NLAs and does not generate significant revenues during a period of economic slowdown will be unable to meet its obligations and will likely be forced to file for bankruptcy.
It is much simpler to obtain financing from a bank if a company has NLAs because this demonstrates that it can pay back the loans it has taken out, even in difficult financial times.
In most cases, this will also result in the borrower being offered a more favorable interest rate on loan.
Even though having net liquid assets is a favorable position to be in, having an excessive amount of liquid assets is not the most beneficial use of cash.
This is because the cash could be invested elsewhere and earned a return on it, rather than just sitting in a bank account doing nothing. But on the other hand, it may also be utilized to pay shareholders dividends.
A company must find the delicate middle ground between having sufficient liquid assets and having an excessive amount of liquid assets.
According to conventional wisdom, a company is considered to be in a healthy financial position if it has sufficient liquid assets to cover its operating costs and meet its six-month short-term obligations.
What do you learn from looking at your net liquid assets?
One of the few metrics that can be used to get a general idea of a company's current financial health is the total amount of its net liquid assets. Cash on hand and marketable securities are two forms of liquid assets that can be used immediately.
Accounts receivables can also be converted into cash in a short time. However, this may not be entirely possible, given that a small proportion of delinquent debt is typically associated with aged receivables.
Because it is difficult or impossible to sell inventory without first taking a significant loss, it is not considered a liquid asset.
Accounts payable, accrued liabilities, income tax payable, and a current portion of the company's long-term debt comprise a typical business's current liabilities.
When current liabilities are subtracted from the list of liquid assets presented above, a company's financial flexibility to make prompt payments is revealed.
When liquid assets are compared to liabilities, it is possible to understand how easily a company could pay off its debts or generate cash for a new venture. This can be done by analyzing the ratio between the two.
It is widely acknowledged as advantageous for businesses to maintain a healthy level of NLAs. This ensures that the company will not face any difficulties if it is required to pay off its suppliers and short-term debts quickly.
Using this number, you can evaluate the state of your finances by performing calculations such as the ratio of liquid assets to net worth.
Suppose a company's liquid assets make up a significant portion of its overall net worth. In that case, this indicates that the company is in a position to make substantial investments without the need for additional financing.
It also indicates how well the company can continue operations despite adverse economic conditions.
If the company did not have sufficient liquid assets, it would have difficulty meeting unexpected financial obligations during slow sales or economic downturns.
It is also more challenging to obtain financing because banks use the ratio of liquid assets to net worth to determine creditworthiness.
This makes it more difficult to obtain financing. But on the other hand, having an excessive amount of NLAs is not always positive for investors.
This is because excessive NLAs indicate that the company may not adequately reinvest its money into growth. Therefore, you should strive to find an equilibrium point when calculating this ratio.
Liquidity of assets is significant for all kinds of businesses, and it can help indicate how well prepared a company is to deal with an unexpected or unexpected circumstance.
Consider the following scenario: there is a recession, and the company in question is deeply in debt but has no liquid assets. If the company cannot secure additional funding, the most immediate consequence will be that it will file for bankruptcy.
It is also true that the more liquid assets a company has, the better its chances are of getting a loan at favorable rates, and the more likely it is to get a loan.
The vast majority of financial institutions require businesses to provide assets as collateral; the ownership of liquid assets demonstrates that the bank loan can be repaid if the company is insolvent.
A company's ability to quickly turn its assets into cash is another indication of its liquidity position. It is possible to conclude that a company is not making efficient use of its liquid assets if it has a large amount of new cash sitting in its bank account doing nothing.
The funds can be put toward investments or distributed as dividends to the company's shareholders.
However, the most difficult challenge is striking the right balance between having sufficient financial security (liquid assets) and avoiding accumulating an excessive amount of unused cash.
Most businesses and financial advisors recommend keeping a liquid asset buffer equal to six months' operating expenses.
This covers ongoing expenses and allows for any unexpected funds that may be needed.
The real-world example
The following items were included in The Container Store Group, Inc.'s current assets and current liabilities sections of the balance sheet as of the 30th of December, 2017:
- Cash: $22.7 million
- Accounts Receivables: $29.5 million
- Inventory: $110.5 million
- Prepaid Expenses: $11.7 million
- Income Tax Receivable: $1.5 million
- Other Current Assets: $10.3 million
- Accounts Payable: $53.8 million
- Accrued Liabilities: $73.5 million
- Current Portion of Long-Term Debt: $9.5 million
- Income Tax Payable: $1.7 million
At this point, a company's net liquid assets would be calculated as follows:
Cash + Accounts Receivables - Current Liabilities = -$86.3 million Cash + $29.5 million Accounts Receivables - $138.5 million
Even though the company has a negative net liquid position, which may be cause for concern, this situation is typical for a retail establishment.
Nevertheless, this suggests that the company is not in the best possible financial position, particularly if the economic climate continues to deteriorate.
- The near-term liquidity position of a company can be assessed by looking at its net liquid assets, which can be determined by subtracting its current liabilities from its liquid assets. This will give you the net liquid assets.
- Examples of liquid assets include cash on hand, marketable securities, and outstanding account receivables. Liquid assets can be converted into cash quickly. They consist of any help that can be converted into cash at a moment's notice, fast or easy.
- Suppose a company has a favorable net liquid asset position. In that case, this indicates that the company is doing well financially and can meet its short-term obligations, such as making payments to its suppliers and reducing its short-term debt. Suppose a company does not have a favorable net liquid asset position. In that case, this indicates that the company is not doing well financially and cannot meet its short-term obligations.
- A company's ability to make new investments without resorting to additional sources of financing is further evidenced by the existence of a favorable net liquid asset position on the company's balance sheet.
Everything You Need To Master Financial Statement Modeling
To Help You Thrive in the Most Prestigious Jobs on Wall Street.
Researched and authored by Ruxue Bai | LinkedIn
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