What Is Liquid Net Worth And How Do You Calculate It?
Liquid net worth is a financial concept that represents the amount of your net asset worth that you have available to be converted into cash quickly. It is a combination of liquidity, the amount of cash in hand, or assets that can be easily converted into cash, and net worth, which is the total value of your assets.
What is Considered a Liquid Asset?
While it is highly likely that you could convert all your assets to cash at a certain point, a liquid asset is one that is easy to convert to cash and won’t cause you undue loses doing so. For example, you could sell your house but having to sell it quickly in order to get cash would most likely cause you to lose money, or may even not be possible due to your mortgage contract. In order to calculate liquid net worth you need to identify assets that:
- Available: The asset must be available and not held as security for a loan or other type of debt
- Readily Convertible: The asset should be realistically convertible in the timeframe you are calculating your liquid net worth, usually within a few days and 6 months.
- Convertible Without Loses: Unless you are calculating a worst case scenario, you should only consider assets as liquid if they are readily convertible without incurring significant loses. It is realistic to expect a small amount of loss due to having to sell quick, but if you will suffer a big loss then the asset is not strictly liquid.
How To Calculate Liquid Net Worth
Your liquid net worth is not a static, set in stone concept. It is fluid and should be calculated depending on your short-term need for cash, as its value will change depending on the market circumstances and the reasons behind your requirement for liquid assets. For example, given enough time to make a sale a piece of real state in a highly valuable area could be considered part of your liquid net worth.
Usually you would only include items on your liquid net worth that you are willing to dispose of. Being able to sell something at a good price doesn’t mean that you want to actually do it, so if your second car or holiday house is important to your financial plans they shouldn’t be used to estimate the amount of liquid assets you own.
Assets such as stocks or annuities, which are generally not as liquid as cash accounts, can be considered liquid assets if you are willing to take the less in terms of future interest or even penalties. It also depends on how quickly you need access to the money, and how much the loss will impact your financials compared with the benefits brought by having access to liquidity.
Real estate and collectables are usually not considered liquid assets, as they are usually difficult to dispose off in a hurry without selling at a loss. However, if you are estimating liquid net worth for a worst case scenario you should assign those items their market value. Always be conservative and use the accounting principle of prudence, as you are estimating how much cash you could get at a given point of time.
If you want to retain an asset for personal or financial reasons, you should consider it illiquid. However, you could be forced to sell that asset due to a change of circumstances and in this case the same principle of prudence applies: assign it a value that could realistically be achieved through a quick sale. Some items are more likely to loss value due to a quick sale than others, depending on the market conditions.
Having to sell illiquid assets due to circumstances is without a doubt a recipe for loss, particularly if your circumstances are known to the buyer who is willing to play on your desperation. Knowing your liquid net worth allows you to plan for the future and work to maintain it at a healthy level. Having some degree of liquidity would allow you to deal with unexpected need or make the most of an unexpected business opportunity, for example. Review your liquid net worth regularly and generate different scenarios in order to be prepared.