Liquid assets are assets your business can convert into cash quickly. This type of asset can help you through business emergencies or cash flow problems because they give you quick cash flow you can use to pay business expenses. If you’re wondering what a liquid asset is and how to use it for your business, this article will guide you through what you need to know.
What is a liquid asset?
A liquid asset is an item of value you can turn into cash quickly and easily. Aside from the obvious option in cold hard cash, marketable securities like common stocks and bonds are also good liquid assets. As a business owner, tracking your liquid assets can help you determine your business’s financial health and your ability to pay debt obligations.
To be considered liquid, an asset must:
- Be in a liquid market (e.g. the stock market)
- Have buyers ready to make a purchase
- Be easy to transfer ownership
- Keep its value when converted into cash
When bookkeeping for your small business, your assets are divided into current and long-term, and these break down further along a scale of liquidity. All liquid assets go under the current assets line on your balance sheet. Businesses can call an asset liquid if it will take less than one year to convert into cash. Your business’s inventory and accounts receivable are current assets that would be considered liquid because they can be transferred into cash in less than one year.
A business’s liquidity shows that its cash flow is sufficient to pay off all of its short-term commitments. Cash and securities are the most liquid because they’re the most readily usable. Assets that aren’t easily converted into cash are called illiquid or non-liquid assets. Some assets may not be able to be converted into cash at all.
But don’t swear off illiquid assets altogether. In fact, it’s important for your business to keep a mix of liquid and illiquid assets. One reason: Liquid assets don’t increase in value as steadily as illiquid assets can. The less accessible an asset is, the higher the interest rate and the more it will likely earn. For instance, a real estate investment is an illiquid asset, but it can increase in value a lot more than the same amount of cash held in a savings account. In fact, the value of a liquid asset can even decrease over time due to factors like inflation.
That said, liquid assets can help you when you’re strapped for cash more readily than illiquid assets. Let’s say you need to bump up inventory and have a good amount of cash sitting in your business checking account. You may be able to pull from that account instantly to cover the costs until you can settle some of your invoices.
Examples of liquid assets
Assets are not equally liquid. Cash is the most liquid of all assets since it’s already the end goal. The definition of “cash” includes bills, coins, and undeposited checks, as well as anything deposited into a checking or savings account.
Cash equivalents like U.S. Treasury bills, certificates of deposit that mature in one year or less, commercial paper, and banker’s acceptances are highly liquid, as well. Other types of assets like stocks, bonds, money market assets, mutual funds, and exchange-traded funds (ETFs) are also considered liquid. Both your accounts receivable and inventory are considered liquid, as well.
An illiquid asset is harder to sell and can even lose money when turned into cash (think collectibles, art, antiques, or debt from companies that aren’t traded publicly). Accounts that charge you for early withdrawals are also less liquid than others.
Liquidity of your financial accounts
It’s helpful to understand how liquid your business is in case you need to use your liquid assets to help with short-term cash flow issues.
Financial analysts commonly use two ratios to examine how liquid a business’s accounts are: the current ratio and the quick ratio. The current ratio compares current assets to its current liabilities to decide whether you’re prepared to face hardship. The quick ratio assesses whether the business would be able to manage its current liabilities with only its liquid assets. Consult a financial professional if you have questions about calculating your business’s liquidity.
Here’s a breakdown of the liquidity levels of each of the bank accounts your business may have:
- Checking accounts: Business checking accounts are the most liquid of all business accounts because they’re the most similar to cash. Checking accounts allow you to pay directly from the account using a debit card or check. Plus, you can use an ATM to withdraw cash instantly without the money losing any value.
- Savings accounts: Savings accounts for business have more restrictions than checking accounts and limit how many times you can withdraw per month (usually around six times at most). So your savings account is a little less liquid because it’s harder to withdraw cash.
- Money market accounts: Money market accounts are like a cross between a checking and savings account, and they limits how frequently you can withdraw your money. They’re about the same in terms of liquidity as a savings account.
- Cash management accounts: Cash management accounts are like checking or savings accounts that are offered by a non-bank entity, like a robo-advisor or brokerage firm. These accounts often don’t limit how many withdrawals you can make, so they are quite liquid.
- Investment accounts: These accounts are for your stocks, bonds, mutual funds, and exchange-traded funds (ETFs). They’re fairly liquid, depending on the account. You can sell the assets and receive cash for them quickly, but selling on the stock market also means you risk selling when the value is low, which hurts the liquidity a bit.
- Tax-advantaged accounts: Think of a retirement account like a 401k, an IRA, and an HSA. These are less liquid because you’ll pay taxes to turn them into cash.
- Trusts: The liquidity of a trust depends on how you set it up. Some trusts are designed to be less readily accessible than others, and therefore less liquid.
What liquid assets mean for small businesses
The more liquid assets you have, the more likely you’ll be able to pay your debts. This is why lenders ask for your bank statements before offering a loan. These assets contribute to your business’s overall net worth, so you’ll appear more low-risk. Lenders want to know that you have emergency funds ready in case your business runs into trouble.
It’s important as a business owner to manage how much cash you have on hand so you can pay your bills and purchase necessary items. Some industries, like banking, even regulate how much a business must hold onto.
But if you’re not comfortable tapping into your emergency fund, consider a loan for small business or a business credit card. Small business loans give you working capital that you can use to pay your business expenses at an interest rate that may be lower than that of a business credit card. Sign up with Nav to get matched to your loan options today.