What is order of liquidity?
Order of liquidity is the presentation of assets in the balance sheet in the order of the amount of time it would usually take to convert them into cash. Thus, cash is always presented first, followed by marketable securities, then accounts receivable, then inventory, and then fixed assets. Goodwill is listed last.
The approximate amount of time required to convert each type of asset into cash is noted below:
- Cash. No conversion is needed.
- Marketable securities. A few days may be required to convert to cash in most cases.
- Accounts receivable. Will convert to cash in accordance with the company's normal credit terms, or can be converted to cash immediately through factoring the receivables.
- Inventory. Could require multiple months to
convert to cash, depending on turnover levels and the proportion of inventory items for which there is not a ready resale market. It may even be impossible to convert to cash without accepting a significant discount.
- Fixed assets. Conversion to cash depends entirely on the presence of an active after-market for these items.
- Goodwill. This can only be converted to cash upon the sale of the business for an adequate price, and so should be listed last.
The order of liquidity concept is not used for the revenues or expenses in the income statement, since the liquidity concept does not apply to them.
In short, the order of liquidity concept results in a logical sort sequence for the assets listed in the balance sheet.