Marketable Securities

What are Marketable Securities and its Types?

The most liquid asset a firm can have is cash in hand. However, it is not a marketable security in the sense that its value doesn’t change. Hence, there is need for marketable securities that are characterised as financial instruments that can be sold easily on a stock or debt exchange.

A strong secondary market for easy sale or high liquidity is the most important characteristic for a financial instrument to be classified as a marketable security as the issuing company should be able to liquidate the security in case of any urgent requirement.

Broad Types of Marketable Securities

Marketable Equity Securities: A firm may acquire shares of companies listed on stock exchanges as an investment or for future acquisition. In case of investment, they are considered marketable securities as the shares can be easily sold and can also their value can also be measured at any point of time.  However, if the shares have been bought with a view of future acquisition, then they are not considered marketable securities.

Marketable Debt Securities: Any bond or debt paper of another company held by a firm that can be easily traded on public exchange can be called marketable debt securities. They are shown as assets on the books of the company.

Marketable Securities Examples

Following are a few examples of marketable securities:

Government paper: Government securities or treasury bills have high liquidity and hence can be easily used to convert assets into cash. They carry low risk and have a deep secondary market.

Commercial paper, corporate bonds, debentures: These securities are issued by companies to raise funds. Commercial papers are short-term instruments and corporate bonds have longer maturity. Corporate bonds lack deep secondary market in India but are usually classified as marketable security. Commercial papers by nature mature within a year and hence too are classified as marketable securities.

Certificate of deposits: These are issued by banks, have short-term maturity and are also tradeable in secondary market, hence qualify to be called marketable securities.

Mutual funds: Most units of mutual funds can be redeemed easily, as well as be measured for market price at any point making them marketable security.

Why Invest in Marketable Securities

A company can always keep all the extra fund generated as cash. But the cash lying idle is a waste as inflation eats into its value. This cash can be used to buy marketable securities that carry low risk, provide some return and can easily by liquated to use whenever then need arise.

For example, a company, let us say ABC Ltd. generated Rs 1 crore in extra cash that it may not need in immediate future. If it keeps the cash idle and one takes a 4% inflation, then the cash in real terms will be worth Rs 96 lakh at the end of the year. However, if the firm were to invest the money in 364-day Treasury Bills that are earning 4.5%, its cash would be worth Rs 1.005 crore at the end of the year after accounting for the 4% inflation.

Also, in case the ABC Ltd. needs that cash urgently in between, the Treasury Bill can be sold in the secondary market. However, there is a slight risk that the T-Bills may fetch less if rates in the market change. That is the risk all marketable securities carry unless held till maturity.

Characteristics of Marketable Securities

The easy definition of marketable security is a financial instrument with chances of some return and can be exchanged easily for cash.

For an instrument to qualify as a marketable security it has to have some or all of these characteristics.

Maturity: If held till maturity, then the maturity profile of the instrument should not be more than a year.

Liquidity: Should have a deep secondary market as a public stock or a debt exchange where it can easily be sold at any time or its market value can be gauged.

Low risk: While nothing can offer the safety of cash, marketable instrument by nature usually should be low risk, and hence usually carry low return.

Accounting for Marketable Securities

Marketable securities are shown as assets in the balance sheet. These financial instruments are further classified mostly as current assets and their treatment will depend on their nature.

To be sold at later date: Let’s say ABC Ltd. holds shares of a blue-chip company as a marketable security. Then it has to show the fair value of the security in the balance sheet, and any temporary change in its value need not be recorded in the profit and loss account. However, changes in value of the security that may be long term have to be amortised or recorded.

Held for trading: If ABC Ltd. has a government bond that has maturity of 10 years, but is being held to be sold at any moment should a need arise, changes in its value are to be recorded in profit and loss account and similarly reflected in balance sheet.

Held till maturity: In case ABC Ltd. plans to hold a 10-year corporate bond of a blue-chip company till maturity, it can disregard temporary changes in valuation. However, if the changes seem permanent, then its fair value has to be reflected in balance sheet and accounted for in the profit and loss account.

The above figures from the 2021-22 annual report of Reliance Industries Limited show how the company has accounted for its marketable securities.

Advantages and Disadvantages of Investing in Marketable Securities.

Like any other investment marketable securities carry on risk and rewards.

Advantages

• Gives some return instead of keeping idle cash
• Can be liquidated easily or converted in cash
• Allows for trading if rare chance of high return happens
• Can be used as security to borrow short-term loan
• Can help cover for inflation risk to assets

Disadvantages

• Even the most secure of instruments can turn risky as seen in AT1 bonds of YES Bank that were extinguished by the RBI during the bank’s restructuring
• If a firm needs money during market holiday it can be an issue
• Short-term volatility can reflect in the profit and loss account or the income statement
• If inflation is higher than return, then asset value diminishes
• How to use marketable securities to gauge financial health

How Marketable Securities Help Measure a Company’s Liquidity

Marketable securities are used in calculating various liquidity ratios of a firm. These ratios show how capable a firm is of paying back its liabilities.

Cash Ratio: This ratio measures if a firm will be able to meet its short-term liabilities using cash and marketable securities.

Cash ratio = (Cash + marketable securities)/ current liabilities.

A ratio of more than 1 is preferred.

Current Ratio: Again, this ratio is used to gauge the ability of a firm to pay off all short-term liabilities using all current assets

Current Ratio = Current assets/current liabilities

Quick Ratio: This helps measures how is the liquidity position of the company. It takes on those assets into account that can be quickly turned into cash, such as marketable securities.

Quick Ratio = Quick Assets/ Current liabilities

Conclusion

Marketable securities help make better use of idle cash or cash that may not be needed urgently for a firm, while still giving it an option to convert it into a liquid asset as and when needed. They usually are low risk, low return investment and are not for profit making, but rather a better use of cash flow management.