When you run a business, it’s your responsibility to stay on top of your company’s financial position. You might think that simply means comparing all your assets (what you own) to your obligations (money you owe). If you’re in the black, you’re good to go–right?
Well, not exactly. Not all assets affect your business the same way. Some assets, such as equipment, are used for long-term growth. You wouldn’t necessarily want to sell them to pay your electricity bill, for example. Other assets, like cash, keep your business running in the short-term, and pay for things like rent, utility bills, supplies and other necessary items.
The assets you use to keep your business running are your liquid assets. Understanding your liquid assets can help ensure you can pay your bills without taking on more debt or selling the assets you need for long-term growth.
Liquid Assets vs. Non-Liquid Assets
In accounting, assets include any items or resources owned by your business, such as cash or property. A liquid asset is a type of asset you can easily convert into cash in a few days without discounting it to sell it.
Any asset that takes a while to convert into cash, or one you have to heavily discount, is a non-liquid asset. Your non-liquid assets are essential for operating and growing your business, but they can’t cover bills and other operating expenses like liquid assets can.
Examples of Liquid Assets
Cash is the most liquid asset in your business. Besides physical currency, the money in your bank accounts also counts as cash since you can access it immediately through ATM withdrawals, checks, and electronic payments.
Liquid assets also include cash equivalents and marketable securities, which are short-term investments you can convert to cash in a matter of days by selling them.
Examples of liquid investments include:
- Bonds: Units of corporate debt you can purchase in exchange for a guarantee that the seller will repay you the principal amount plus interest
- Money market accounts: A type of mutual fund composed only of highly liquid assets
- U.S. Treasury Bills and Treasury Bonds: Purchases of government debt that pay you back interest, usually within one year, but you can also sell them on secondary markets
- Mutual funds: Can be sold each day at the close of the day, and you’ll usually receive payment the next business day
- Stocks: Can be sold on stock exchanges quickly and provide you with funds within days of the sale
- Exchange-traded funds (ETFs): Investment funds that trade on public exchanges like stocks, so you can sell them quickly
- Certificates of Deposit (CD): A time deposit in a bank account that earns higher annual interest but may require a penalty fee for early withdrawal
- Some inventory: Any inventory you can sell in a few days without drastically reducing the price.
- Accounts receivable: Payments due from customers you can collect within a few days.
Even within these examples, there are different liquid types. Assets that you can sell faster are more liquid, and those that take more time to sell are less liquid.
Examples of Non-Liquid Assets
Long-term assets, also known as non-current assets, are resources and items your company owns that will continue to provide value for more than one year, like buildings and equipment.
Long-term assets cannot be converted to cash in a matter of days unless you offer a big discount. As such, they are not considered liquid assets.
Examples of illiquid assets include:
- Property
- Buildings
- Equipment
- Collectibles (more common for individuals as opposed to businesses)
- Private equity funds (which have strict regulations on when you can sell)
- Intangible assets (such as brand recognition and intellectual property)
Buying Liquid Assets
You might be wondering why businesses might purchase liquid assets instead of putting excess cash in the bank to serve as an emergency fund.
Purchasing assets like stocks, bonds, or CDs lets you earn higher interest rates on your money than you would if you had cash in your savings or checking account.
For example, the average high-yield savings account earns 0.6 percent interest annually, whereas money market funds can offer .7 percent interest, and CDs can earn 1 percent or more.
If you end up not needing the funds, you earn more interest. In the meantime, these short-term investments can help cover the difference if your cash runs low.
It should be noted that you may have to sell your liquid assets at a slight loss if the market is down and you need immediate cash.
Liquid vs. Non-Liquid Markets
For an asset to be considered liquid, you need an established market where you can sell that asset for quick cash. This is known as a liquid market.
Common examples include foreign exchange and stock markets. Both have plenty of buyers and sellers and established prices and let you sell electronically so you can get paid within days of the sale.
In contrast, non-liquid markets typically can’t generate cash within days unless you sell an asset significantly below market price. The real estate market serves as an example of an illiquid market.
Liquid Assets on the Balance Sheet
On the balance sheet, you’ll find liquid assets listed as current assets, which are the resources your company expects to sell or use within the course of the year.
However, not all current assets are considered liquid assets. Inventory that you can’t sell quickly and prepaid expenses (like rent or utility bills) are considered current, but not liquid since they take more than a few days to convert to cash.
For example, if you need to convert all of your inventory into cash within a few days, you will most likely have to sell your products at a steep discount, which means you will not receive their full worth.
Liquid Assets and Analyzing Your Finances
Understanding your liquid assets helps with internal financial analyses and preparing external reports for your stakeholders.
However, it’s not enough to look at your liquid assets alone. To understand your short-term financial position, you must compare them with your current obligations (or payments that will need to be made in the next year).
To compare, business owners and investors use liquidity ratios such as the quick ratio and the current ratio.
The quick ratio compares liquid assets to current liabilities and is calculated as follows:
Quick Ratio = Liquid Assets / Current Liabilities
A quick ratio higher than 1 means you have more liquid assets than current liabilities, so you’ll be able to pay for them without taking on debt or selling long-term assets.
A quick ratio lower than 1 indicates that your liquid assets are not enough to cover current liabilities. If that’s the case, you want to look at your current ratio, which is calculated as:
Current Ratio = Current Assets / Current Liabilities
The current ratio includes inventory and prepaid expenses. Using these, you’ll have a better idea if your liquid assets plus inventory sales are enough to cover your operating expenses and debt payments for the next 12 months.
Why Are Liquid Assets Important?
Most companies treat liquid assets as cash, which means their primary purpose is to pay for current liabilities such as short-term debt, payroll, rent, and other operating expenses.
If you don’t have enough liquid assets on hand, you need to find other ways to pay your bills, such as selling long-term assets or taking on debt.
However, selling long-term assets or securing a large number of loans makes it difficult to invest in growing your business. Eventually, you end up in a situation where you’re just trying to stay afloat.
By keeping track of your asset types and current liabilities, you can improve your business’s cash flow and put yourself in a position to keep operating while also having enough resources to invest in growth.
Ready to transform your business into a profit-pumping machine? Learn how with our monthly newsletter.
