Marketable Securities
Marketable securities are liquid financial instruments that can be quickly converted into cash at a reasonable price, typically within one year. Companies use them to earn a return on idle cash while preserving ready access to funds for short-term needs.
How they work
- Businesses invest excess cash in short-term, highly tradable instruments instead of letting cash sit idle.
- Marketable securities must have an active secondary market that enables prompt buying and selling and provides reliable price quotes.
- Because they prioritize liquidity and safety, these securities generally offer lower returns than less liquid investments.
Common examples:
– Treasury bills
– Commercial paper
– Bankers’ acceptances
– Money market instruments
– Publicly traded common and preferred stock
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Types of marketable securities
- Equity securities: Publicly traded common or preferred stock held by a company. If expected to be sold within a year, they are classified as current assets; otherwise as noncurrent. Many are reported at the lower of cost or market value.
- Debt securities: Short-term bonds or notes (e.g., Treasury bills, commercial paper) intended to be sold within a year and held as short-term investments. These require an established secondary market so they can be liquidated at predictable prices.
If an investment is made to obtain control of another company, it is typically classified as a long-term investment rather than a marketable security.
Accounting and valuation
- Marketable securities are included in current assets on the balance sheet when they are expected to be sold within one year.
- Valuation and reporting rules differ by security type and accounting standards: equities are often recorded at the lower of cost or market when classified as current, while short-term debt instruments are generally held at cost until sold or a gain/loss is realized.
Role in liquidity analysis
Marketable securities are a key component in evaluating a company’s ability to meet short-term obligations through common liquidity ratios:
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- Cash ratio = (Market value of cash + Marketable securities) / Current liabilities
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A cash ratio above 1.0 indicates the firm could cover short-term liabilities immediately; many firms hold lower ratios because excess cash or highly liquid investments reduce return.
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Current ratio = Current assets / Current liabilities
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Measures ability to pay short-term debts using all current assets (including marketable securities).
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Quick ratio = Quick assets / Current liabilities
- Quick assets exclude less liquid current assets; marketable securities are included as quick assets.
Key considerations
- Liquidity vs. return: Higher liquidity typically means lower expected return.
- Secondary market depth: A robust market is essential for fast, reliable liquidation at fair prices.
- Holding period: Classification (current vs. noncurrent) depends on management’s expected holding horizon.
- Purpose: Companies use marketable securities to park cash temporarily, maintain flexibility for transactions (e.g., acquisitions, contingent payments), and earn modest returns.
Bottom line
Marketable securities are short-term, highly liquid investments that help organizations manage cash efficiently while preserving the ability to meet near-term obligations. They play a central role in liquidity metrics and short-term treasury management but generally yield lower returns due to their safety and ease of conversion to cash.