Chapter 2, Problem 2.1CTF

What types of accounts are the most liquid?

Summary Introduction

To discuss: The types of accounts that are highly liquid in nature.

Introduction:

The liquidity of an asset refers to its ease of converting into cash without any significant loss in its value. The balance sheet records the assets based on the decreasing order of liquidity. In other words, the most liquid assets are recorded first and the least liquid assets are recorded at the end.

Explanation of Solution

The liquidity of the accounts varies based on their ease and quickness of converting itself into cash without any significant loss in its value. The following types of accounts are highly liquid in the decreasing order of liquidity:

• Cash in hand account:

  Cash in hand is highly liquid because it is easily convertible and available for payment at any time.

• Cash at bank account:

  It is also highly liquid because the company can withdraw cash from the bank without any loss in value of the asset.

• Short term investments:

  Short-term investments such as treasury bills, securities, and certificate of deposits are liquid because there is a ready market for its conversion to cash without any loss.

• Accounts receivable:

  It refers to the amount owed by debtors to the company. They are relatively liquid as they will be converted into cash in a short period.

• Inventory:

  It is the least liquid in the current assets because the inventory can be converted into cash only when the sales occur.

Conclusion

The liquidity of an asset refers to the quickness of converting into cash without any loss in value. Cash in hand, cash at bank, and inventory are some of the examples of liquid assets in the decreasing order of liquidity.