Order of Liquidity

Updated on January 3, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is the Order of Liquidity?

Order of liquidity is the presentation of various assets in the balance sheet in the order of time taken by each to get converted into cash, whereby cash is considered as the most liquid asset, followed by cash and cash equivalents, marketable securities, account receivables, inventories, non-current investments, loans and advances, fixed assets (both tangible and intangible).

Order of Liquidity of Assets

  1. Cash is the most liquid asset and doesn’t need any conversion.
  2. Bank The balance available is also the liquidated assets without further conversion.
  3. Marketable Securities Marketable SecuritiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more are the assets such as commercial paperCommercial PaperCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note.read more, bonds, the stock traded on an exchange, preferred sharesPreferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.read more, exchange-traded fundsExchange-traded FundsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange.read more, etc. these assets can be converted into cash in a few days.
  4. Accounts Receivable Amount due from the customers of the firm or organization for which goods/services have been provided, and the bill has been raised, but the amount is due to be collected. These get converted into cash according to the company’s credit policy.
  5. Inventory It is the stock lying with the company in either raw material, work in progress, or finished goods form. The inventory conversion into cash could take months, depending on the sales level.
  6. Fixed Assets Assets like the land, plant, building, machinery, furniture, vehicles, etc., all are part of fixed assets. Selling these and converting them into cash is a long-term process and requires a few days to a month.
  7. Goodwill This is the least, but a liquid asset’s realization into cash occurs only at the time of sale of the business.
Order of Liquidity

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Order of Liquidity for Balance Sheet

The balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more is a part of a financial statementFinancial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more that presents the company’s assets, liabilities, and owners’ equity at a particular point in time, thereby providing insights into an entity’s financial position. Assets are listed in the balance sheet in order of their liquidity, where cash is listed at the top as it’s already liquid. No conversion is required. The next on the list are marketable securities like stocks and bonds, which can be sold in the market in a few days; generally, the next day can be liquidated.

Next, the money owed by the business in the normal course of sales, which is accepted by the general credit terms of the company, is generally known as accounts receivables. These receivables generally have a 30 – 60 days credit period to liquidate themselves. Next, inventory is the stock lying with the company and can be converted into cash from one month to the time of sales. Sometimes inventory can be sold quickly, so its position may vary from organization to organization. Then comes the non-current assets like plant and machinery, land and building, furniture, vehicles, etc.; they need a longer selling period and thus need time in liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more.

Last on the balance sheet is the goodwill, which could be realized only at the time of sale or any other business restructuring. Liquidity is the given adequate consideration or priority when preparing the balance sheet. It is the first document seen by the lenders/investors and other stakeholders to understand the company’s position. Liquidity is the ability of an asset to get converted into cash in terms of time. Assets that can convert into cash within 12 months are considered current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more, while others are treated as non-current assetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark.read more.

The listing of assets as per liquidity is as follows: –

#1 – Current Assets –

#2 – Non-Current Assets –

Importance of Order of Liquidity

LiquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more measures the capability of the cash generation capability of any asset. It gives an idea about the dividends that the shareholders will receive. With a uniform listing criterion established by an accounting GAAP, it becomes easier for various stakeholders to understand, analyze the company’s balance sheet and make decisions accordingly. This increases both intra-company and inter-company balance sheet comparability. In addition, liquidity order listing gives impressions about various liabilities repayment capacity of a company, like loan installments, debentures redemption, or any other short-term liability like payment to vendors.

Advantages

  • This displays the company’s ability to turn assets into cash.
  • It bifurcates more liquid assets from less liquid assets with their true values.
  • It gives lenders and buyers a clear view of the organization. The liquidity ratio of the business will portray to the creditors and investors how financially strong the company is.
  • It helps in decision making as when your company’s liquidity ratio is monitored timely, management will be in a better position to make quality decisions that will help you gain more profits and growth.
  • Liquidity order helps in times of emergencies by providing quick funds to overcome the scenario that the organization is facing.

Disadvantages

  • Different accounting GAAPs may provide different listing criteria, and thus, the company’s financial position comparability gets affected.
  • Liquidity listing of assets may not always be useful for each stakeholder. Investors who wish to invest for the long-term period will be least bothered about the company’s current liquidity position.
  • Certain assets like prepaid and deferred expenses may not find an adequate position per listing criteria as these will never be realized in cash. Still, these are current assets because services against payment processes are yet to be utilized.

Conclusion

Order of Liquidity can be described as a listing criterion specified by applicable accounting GAAP, which decides the order of assets presentation in its balance sheet according to its cash generation capability. This is helpful for varied stakeholders in comparing, analyzing, and decision making as they can easily compare two or more balance sheets of either the same company or any other company. As per this, cash is considered the topmost liquid asset, whereas goodwill is considered the most illiquidIlliquidIlliquid refers to an asset that cannot be converted to cash. Such assets suffer a valuation loss when sold in exchange for cash. Bonds, stocks and properties are some examples of illiquid investment.read more asset as it cannot generate cash until the business gets sold.

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