What Is The Order Of Liquidity ?
Liquidity refers to the ease with which any item can get converted to cash or at least near to its present value within a period of one year. ‘Order of Liquidity’ usually refers to the order in which the balance sheet items are arranged depending on the extents to which they are liquid. |
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These items are typically arranged in a descending order of their liquidity. That is, cash, which is undeniably the most liquid asset of a company, appears first on the list of items in a balance sheet. It is followed by current assets of the company. Further, the various current assets are also arranged in descending order of their liquidities or the nearness of their character to cash. Thus, on the current assets’ list, accounts receivable appears first, followed by the inventory items.
A company’s Chart of Accounts is typically prepared using 3 different methodologies -- Accounting Types, Order of Liquidity, and Account Numbers. The ‘order of liquidity’ method, which lists all accounts, within their respective accounting types, in a descending array of liquidity. This kind of classification of account types, based on liquidity, is very important for assessing the working capital requirements of the company. In this method, the main accounts of liabilities and assets are further sub-divided into short-term and long-term items. Items having same degree of liquidity are usually grouped together on the balance sheet and reflected as a single item.
The various accounting types include the assets, liabilities, equity, revenue, cost of goods sold, and miscellaneous expenses and revenues, in that order. However, the ‘order of liquidity’ applies only to those accounts of balance sheet that can be converted to cash. Therefore, expense and revenue accounts are exempt from this rule.
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