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You may have heard financial professionals talk about whether a company or individual has liquidity, but what exactly does this mean? Here’s what you need to know about the differences between liquid assets and fixed assets and the role of each in a financial plan.
What is a liquid asset?
A liquid asset is an economic resource that can be quickly and easily converted into cash. Liquid assets can be sold or exchanged without significantly affecting their value.
Examples of liquid assets include:
- Cash
- Treasury bills
- Money market or savings accounts
- Short-term bonds
- Money Market funds
In terms of financial planning, liquid assets are critical because they provide the means to meet immediate financial obligations, cover unexpected costs and provide a degree of financial flexibility.
What is a fixed asset?
A fixed asset, often called a tangible asset or property, plant and equipment (PP&E), is a long-term asset that retains value over time and can be used to generate income. These assets are tangible in nature, meaning they have a physical form that you can touch and see.
In a business context, fixed assets such as buildings, machines, vehicles and office equipment are used for production and revenue generation. They are expected to provide economic benefits to a company for more than one year and are listed on the balance sheet as property, plant and equipment.
However, it is important to note that fixed assets are not exclusive to businesses. Individuals also own fixed assets, such as a house, a car, or valuable collectibles such as art and jewelry. These assets contribute to an individual’s wealth and can be a source of financial security.
Fixed assets would not be used for immediate financial needs because the sales process can take a long time and you may need the asset for its intended use. For example, you normally wouldn’t sell your house or car to pay emergency expenses or regular bills.
How do liquid assets differ from fixed assets?
Liquid assets and fixed assets differ mainly in terms of their liquidity and the way they are used. Liquid assets, such as cash and marketable securities, can be quickly converted into cash, making money immediately available to cover short-term financial needs.
Conversely, fixed assets such as buildings and machinery are designed for long-term use in the company’s operations and cannot be easily converted into cash. An individual may own fixed assets such as their home, rental properties, or a car.
Fixed assets can also depreciate in value over time and may require regular maintenance to maintain their usefulness. Consider the maintenance requirements associated with owning a car, such as oil changes, new tires or engine maintenance.
How do liquid and fixed assets fit into financial planning?
Both liquid and fixed assets play a crucial role in financial planning. Liquid assets, such as cash reserves, provide a safety net for unexpected expenses, emergencies, or short-term financial needs. They provide financial flexibility, allowing individuals and businesses to respond quickly to financial opportunities or obligations. Building an emergency fund is one of the first things financial advisors recommend to clients to build financial stability.
On the other hand, fixed assets such as real estate can also contribute to long-term financial stability and wealth accumulation. They can be used to generate income and can increase in value over time depending on the type of asset.
Balancing liquid and fixed assets is the key to effective financial planning, ensuring preparedness for immediate financial needs while investing in long-term financial growth.
In short
Both liquid and fixed assets play a crucial role in financial planning. While liquid assets provide immediate liquidity and flexibility, fixed assets can contribute to long-term stability and wealth accumulation. Balancing these two types of assets is essential to ensure that both short- and long-term financial needs are met.
