Liquid net worth

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Liquid net worth
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Liquid net worth is the entity's sum of liquid assets’ value subtracted by its liabilities[1]. In other words, it's how much cash and assets that can be quickly turned into cash are available. Liquid net worth can be calculated for any entity that contains assets: companies, institutions, governments, individuals or even sectors.

Liquidity of assets

Financial liquidity is entity's ability to meet it's liabilities without suffering catastrophic consequences[2]. It is directly related to what type and how much properties does company, government, institution or individual have. To evaluate financial liquidity, assets have to be divided into two categories[3]:

  • Liquid assets (current assets, short-term assets) are subject's assets that can be easily converted to cash. These include: savings, stocks, bonds, bills, mutual funds, marketable securities. Liquid assets are easy to evaluate and generate little or no loss when quickly disposed, even though their actual value might differ from face value. They provide liquidity.
  • Illiquid assets (nonliquid assets, long-term assets) are subject's properties that are hard to sell quickly and/or without loss in value. They are part of net worth, but are object to appreciation and depreciation which makes them harder to value. Illiquid assets include: real estates, vehicles, equipment - properties whose values usually decrease over time - but also investments, collectibles and antiques that are acquired to generate profit in future.

It's worth noting that liquid assets can have different liquidity. Company's bank savings are usually object to quick cashing - they are highly liquid. Tax refunds can have defined acquisition date (although short when compared to, for instance, return of investment) - they have lower liquidity compared to savings.

Liquid Net Worth vs. Net Worth

Net worth can be defined as value of all subject's assets minus it's liabilities[4]. For a company, it will be its carrying value from financial statements.

Net worth can be also defined as how much value does entity have in assets. On the other hand, liquid net worth is entity's value available at hand. The relation between both can be defined: net worth is liquid net worth plus illiquid assets.

Higher net worth means overall better financial health of an individual or entity. Higher liquid net worth means better ability to withstand or perform dynamic financial changes.

It must be noted that neither liquid net worth nor net worth are clear indicators of company's market value.

Importance of liquidity of assets

Usually, most of entities’ assets are not liquid. Preferably, liquid assets are converted into investments and other means of development to provide long-term profit. However, low liquid net worth leads to funding liquidity risk. This means entity is threatened to not have enough liquid assets to meet short-term payment obligations (due within one year), even though they could be met later[5].

Financial crisis of 2007-2008 was result of loss of liquidity by financial institutions when high delinquency rates on mortgages led to devaluation of securities[6].

References

Footnotes

  1. Heaton, J., Lucas, D. 1999, p. 5
  2. Vodová, P. (2013), p. 114
  3. Epstein, L. (2014), p. 30-31
  4. Weisbrod, B. A., Hansen, W. L. (1968), p. 1315
  5. Vodová, P. (2013), p. 114
  6. Gauthier., C., He, Z., Souissi, M. (2010), p. 1

Author: Karolina Próchniak