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You may have heard financial professionals talk about whether a business 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 impacting their value.
Examples of liquid assets include:
In terms of financial planning, liquid assets are crucial as they provide the means to meet immediate financial obligations, cover unexpected costs and offer a degree of financial flexibility.
What is a fixed asset?
A fixed asset, often referred to as a tangible asset or property, plant, and equipment (PP&E), is a long-term asset that holds value over time and can be used to generate income. These assets are tangible in nature, meaning they have a physical form you can touch and see.
In a business context, fixed assets such as buildings, machinery, vehicles, and office equipment are used for production and income generation. They are expected to provide economic benefits to a company for more than a year and are listed on the balance sheet as PP&E.
However, it’s important to note that fixed assets aren’t exclusive to businesses. Individuals also possess fixed assets, such as a home, a car, or valuable collectibles like art and jewelry. These assets contribute to an individual’s net worth and can be a source of financial security.
Fixed assets wouldn’t be used for immediate financial needs because the sale process can be lengthy and you may need the asset for its intended use. For example, you typically wouldn’t sell your house or car to pay for an emergency expense or regular bills.
How do liquid assets differ from fixed assets?
Liquid assets and fixed assets differ primarily in terms of liquidity and how they are used. Liquid assets, such as cash and marketable securities, can be converted into cash quickly, providing immediate funds to cover short-term financial needs.
Conversely, fixed assets like buildings and machinery are designed for long-term use in a business’s operations and are not easily converted into cash. An individual may hold fixed assets such as their home, rental properties or a car.
Fixed assets may also depreciate over time and can require regular maintenance to maintain their usability. Think of the maintenance requirements that come 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 vital roles in financial planning. Liquid assets, such as cash reserves, provide a safety net for unexpected expenses, emergencies, or short-term financial needs. They offer financial flexibility, allowing individuals and businesses to respond quickly to financial opportunities or obligations. Building an emergency fund is one of the first things that financial advisors recommend clients do 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 may be used for income generation and can appreciate over time, depending on the type of asset.
Balancing liquid and fixed assets is key to effective financial planning, ensuring preparedness for immediate financial needs while also investing in long-term financial growth.
Bottom line
Both liquid and fixed assets play crucial roles in financial planning. While liquid assets provide immediate liquidity and flexibility, fixed assets can contribute to long-term stability and wealth accumulation. It is essential to balance these two types of assets to ensure both short-term and long-term financial needs are met.
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