Marketable SecuritiesExplained with Journal Entry Examples

Written By:
Lisa Borga

Marketable securities are liquid assets that are relatively easily able to be converted into cash.

These securities are easily bought and sold through marketplaces and are an essential class of investments.

These investments are so liquid because they typically are short-term investments meaning they will mature within one year, and their rate has a low impact on the prices at which they are traded.

Common examples of marketable securities include stocks, bonds, bills receivable, and money market instruments.

Marketable Securities Explained

Most companies will maintain a cash reserve in order to remain prepared for unexpected expenses which may arise as well as sudden opportunities for investment or expansion which require a rapid response.

However, generally, a business will not choose to maintain the majority of its current assets as cash.

Instead, most businesses will invest in short-term investments such as marketable securities, which allow them to earn returns on their assets while still allowing them to liquidate them relatively easily if the need for cash arises.

Marketable securities possess certain characteristics, which include the ability to be purchased or sold on a public stock or bond exchange.

As a result, marketable security will be classified as either marketable equity or debt security.

Another requirement is that there is a strong secondary market for the security, which allows these securities to possess their most distinguishing characteristic, which is high liquidity, by allowing them to be quickly bought and sold as well as providing a fast and accurate valuation of the assets.

Because these investments are highly liquid, they generally have a low risk, but this also means they will typically have a low rate of return.

Marketable Securities and Liquidity Ratios

A company’s liquidity is often considered by investors when judging its ability to meet its short-term obligations.

Because marketable securities can be relatively quickly converted into cash, marketable securities can play a major role in calculating these ratios.

Some particularly useful liquidity ratios include the cash ratio, current ratio, and quick ratio.

Cash Ratio

The cash ratio is a critical measurement of a company’s liquidity.

The formula for this ratio is:

Cash Ratio = Cash and Cash Equivalents / Current Liabilities

The cash ratio is a measurement of a company’s ability to meet all of its current liabilities using only its cash or cash equivalents, such as highly liquid marketable securities.

Investors and banks may consider this information when deciding if a company will be likely to be able to meet its obligations without liquidating other assets.

Any number equal to or greater than 1 indicates that it will be able to meet its obligations.

However, for most companies, the cash ratio will reveal a low number as maintaining significant cash or near-cash reserves is rarely the most profitable strategy.

A cash ratio significantly higher than 1 may even indicate mismanagement, such as failing to invest in profitable projects or investments.

It could also indicate that the company has reason to believe its profits could suffer in the future, and it is preparing for a loss of revenue.

Current Ratio

The current ratio is also sometimes referred to as the working capital ratio and measures a company’s ability to meet its short-term obligations using all of its current assets, including inventory and marketable securities.

The formula for this ratio is:

Current Ratio = Current Assets / Current Liabilities

Acid Test Ratio

The acid test ratio, also known as the quick ratio, measures a business’s ability to use only its cash and near-cash assets to meet its current liabilities.

This includes only the most liquid of marketable securities, which can be converted to cash immediately.

The formula for the acid test ratio is:

Acid Test Ratio = (Cash & Cash Equivalents = Marketable Securities = Accounts Receivable) / Current Liabilities

Classifications

There are two primary classifications of marketable securities which are included on a company’s balance sheet.

These include:

Equity Securities

This type of marketable security is an equity instrument that is readily traded on stock exchanges and includes either common or preferred shares.

Notably, not all equity held by a company may be considered a marketable security.

If equity is not held for the purpose of trade or sale and is instead held for the purposes of acquiring or maintaining control in another company, they are not considered marketable securities.

Instead, they will be listed on the balance sheet as a long-term investment.

Debt Securities

Marketable debt securities are any debt security that is sold on the bond market that is expected to be held for less than one accounting period.

Once purchased, marketable debt security should be recorded on the balance sheet as a current asset at cost until it is sold and a gain or loss is realized.

In any case, where debt security is expected to be held longer than one accounting period, it should be listed on the balance sheet as a long-term investment.

Examples of debt securities include corporate bonds, government bonds, certificates of deposit, and treasury bills.

Generally, these securities have a low risk and correspondingly possess a very low return.

Accounting for Marketable Securities

Because of their high liquidity, marketable securities will generally reach maturity within a year, and as a result, they will be recorded as current assets on the balance sheet.

A company may also choose to classify these marketable securities in one of three different ways depending on how the purpose for which they were bought.

These include:

• Held for Trading: This includes securities that a company intends to sell for a profit within a single accounting period or one year. They will be shown at their fair value on the balance sheet, and changes in value will be recorded on the income statement as an unrealized loss or gain.
• Held to Maturity: This includes securities that will be held until the date they reach maturity.
• Available for Sale: This category includes marketable securities which do not fall into either of the prior two categories. The holder may intend to hold them for an extended period or sell them before their maturity date. They will be required to be recorded on the balance sheet at market value, and any change in value will be recorded on the income statement as an unrealized gain or loss.

Key Takeaways

• A distinguishing feature of marketable securities is that they are highly liquid, meaning that they can be readily converted into cash.
• Marketable securities are easily transferable.
• Marketable securities typically will become mature within a single year. However, this is not required.
• Common examples of marketable securities include government securities, stocks, bonds, and bills receivable.