Generally, marketable securities are classified as current assets in the balance sheet of the business. The reason is that these are the financial instruments that can be converted into cash on short notice.
These securities are highly liquid and mature in less than a year. Further, there is no massive impact on the selling/buying prices of short notice. Hence, marketable securities are classified as current assets.
Companies use these securities to earn additional returns on cash resources. That’s because cash in the bank accounts gets depreciated due to inflation.
However, if the business has invested in the bonds with the maturity of more than one year, it will not be classified as a current asset. So, irrespective of the type and nature of the marketable security, the maturity analysis, and business intention are more important in classifying the assets as current or non-current.
So, if marketable security is held to maturity (and the maturity date is more than one year), it cannot be classified as a current asset.
Let’s understand the characteristics that impact the liquidity and classification of the marketable securities under current assets/non-current assets.
Characteristics of marketable securities
Following are some of the characteristics of marketable securities.
- These securities are available on the public exchanges – (active purchase and sale).
- These securities are expected to be converted into cash within one year.
- These securities have a maturity date of year or less.
- A strong secondary market exists for these securities.
- These securities have higher liquidity or can be converted readily into cash.
Categories of marketable securities
1- Trading securities
These marketable securities are purchased by the business to earn a short-term return. The business intends to hold an asset for less than one year. Any fluctuation in the fair value of assets is reflected in the accounting record to ensure the impact of fluctuation is recorded in the business books.
Any gain/loss arising on these securities is recorded in the income statement of the business. These securities are classified as current assets as the business can sell them at any moment.
2- Held to maturity
The business has the choice to hold the security for a short period or till maturity. If the business has the intention to hold the security and collect cash flow on maturity, the security is classified as held to maturity.
This type of marketable security may be classified as current/non-current. If the maturity date of the security falls under one year, it’s classified under current asset.
On the other hand, if the security’s maturity date is more than one year, it’s classified under non-current assets. Further, short-term fluctuation in the market value of such securities is not recorded in the accounting record.
3- Available for sale securities
The securities are purchased to sell before reaching the date of maturity. Further, these securities are recorded at fair value, and any unrealized gain/loss is taken to the other comprehensive income.
The concept of classification as current/non-current stands the same as the fact that if the management has the intention to sell the asset within a year, it’s classified as a current asset and vice versa.
So, it’s important to note that the maturity date is more relevant in classifying the security as current/non-current.
Types of marketable securities
There are two main types of marketable securities that include marketable debt securities and marketable equity securities.
Marketable debt securities – These are the short-term bonds issued by the public company / Government. Usually, these securities are issued for a term of less than one year, and hence, are classified as a current asset in the balance sheet.
Here are some of the examples of marketable debt securities.
- Corporate bonds
- Government bonds
- Treasury certificates
- Deposits certificates
Marketable equity securities – These are the shares issued by listed companies on the stock exchange. An investor buying equity becomes the owner of the company. However, the classification of investing in shares is dependent on the business intends to hold the shares.
If the business intends to hold shares for a long period, it’s classified as non-current and vice versa. However, if the intention to purchase the shares is to control some entity, it should be classified as a long-term investment.
The marketable equity securities include common stock and preference shares.
Hybrid securities – These types of security contain characteristics of both debt and equity. The prime example of a hybrid example is a convertible bond, these are the bonds; however, these bonds can be converted to shares.
Derivatives – These are securities that do not have innate value. Instead, their value is dependent on the fluctuation of the underlying security.
Liquidity ratios and marketable securities
Marketable securities are included in the calculation of liquidity ratios. A higher balance of the marketable securities leads to enhanced liquidity, and all these securities are included in the calculation of liquidity current ratios, quick ratios, and cash ratios.
Marketable securities are included in the current assets and directly impact the current ratio. The following formula calculates this ratio.
Current ratio = current assets/current liability
If the current ratio is one or more, the business is considered to be liquid. Similarly, the quick ratio is the same as the current ratio. However, inventory is removed from the current asset. The following formula can calculate the quick ratio.
Quick ratio = (current assets – inventory)/current liability
The cash ratio compares to cash and cash equivalent balance with the current liabilities. It helps to understand if the business has sufficient cash resources to meet the liabilities that fall due in a year. The following formula can calculate the cash ratio.
Cash ratio = Cash and cash equivalents/ current liability
It’s important to note that marketable securities with a maturity of less than one can be included in the closing balance of the cash flow statement. It’s because these securities can be covered under cash equivalents.
Conclusion
Marketable securities are financial instruments that are equity/debt-based. These securities are highly liquid and can be sold on the primary and secondary markets of the country. The marketable securities are usually qualified as current assets because these are highly liquid and can be converted into cash quickly.
Marketable securities may be classified as held for trading, available for sale, and held to maturity. Held for trading is purchased to sell shortly and generate a return; these are classified as current assets.
Similarly, available for sale are sold before maturity. However, if the intention to sell falls in the period more than a year, these securities are classified as non-current. Likewise, held to maturity is classified based on the date of maturity; if the date of maturity is less than a year, it’s classified as a current asset.
Further, types of marketable securities include equity and debt instruments. Equity security is considered more liquid as these can be sold on stock at any time. On the other hand, debt security is considered less liquid due to maturity and other aspects.
Frequently asked questions
Why are marketable securities considered to be liquid?
Marketable securities are expected to be liquidated within a year, and these assets can be realized into cash in a short period. Further, a primary and secondary market exists for these securities that help realize the marketable securities. Hence, these securities are considered to be liquid.
Which type of market securities are considered to be the most liquid?
Treasury bills are considered the most liquid asset, and it’s considered to have the least risk because backed by Government. Hence, these securities are traded in a massive volume.
Which types of marketable securities are more liquid?
Generally, equity investment is considered to be more liquid than investing in bonds. It may be difficult to sell the bonds due to the date of maturity and other factors.
On the other hand, equity security can be sold on the stock exchange. Hence, equity security is considered to be more liquid than debt securities.
What are the examples of marketable securities?
Marketable securities include bonds, stocks, options, futures, money market instruments, and hedge funds, etc.
