What are liquid assets? Why they're critical for businesses
- What are liquid assets?
- What are liquidity ratios?
- Why liquid assets matter for a business
- Ramp: Increasing your liquidity
Liquid assets are pretty straightforward. Liquidity refers to how quickly you can turn an asset into cash. The more liquid an asset, the easier it is to convert it.
Asset liquidity is a critical part of your business’s financial profile. It can also help small business owners calculate their net worth and aid in financial planning.
What are liquid assets?
Liquid Assets
Liquid assets are a type of asset you can quickly convert to cash without a loss in market value.
Liquid assets give businesses flexibility in responding to market shocks or paying off debt. You record them on your company’s balance sheet, and they’re considered cash equivalent on a financial statement.
Here are some examples of liquid assets:
- Cash: Your most liquid asset, cash is the most flexible form of payment
- Checking accounts, savings accounts, certificates of deposit: You can access funds transferred to one of these almost anywhere and anytime
- Accounts receivable: The money owed to your business for services or goods you already provided is regarded as a liquid asset
- Marketable securities, stocks, bonds, mutual funds, money market funds: Given the number of eager buyers, these investments can often be sold on short notice without losing substantial cash value and are therefore regarded as liquid
A non-liquid asset is the opposite of a liquid asset. These assets won’t convert to cash readily or without the risk of losing value. For example, real estate holdings take time to sell, so they’re non-liquid. So are retirement accounts, which may incur penalties for early withdrawal.Knowing the total value of your business’s liquid assets is crucial. This lets you gauge how much cash you could quickly access in a financial emergency or if your cash flow forecasting was off.It’s likely easier and more cost-effective to tap into your liquid assets for quick cash. Obtaining loans is more challenging during a liquidity crunch, when businesses often face higher interest rates from lenders. These conditions could increase the risk of your business failing or taking on significant debt.
What are liquidity ratios?
Liquidity ratios help you measure your business’s ability to pay off current debt obligations without outside financial assistance. They aid in assessing your current liabilities compared to your liquid assets, enabling you to determine how much short-term debt you can manage if you face unexpected challenges.
These liquidity ratios provide your finance team and investors insight into how well your company manages its working capital and whether it can pay off bills as they arise. It also presents a comprehensive view of where your business stands with and without semi-liquid assets.
Two of the most common types of liquidity ratios are the current and the quick:
Current ratio
The current ratio measures your business’s ability to pay off your current liabilities within a year using current business assets (e.g., cash) and semi-liquid assets (e.g., inventory and accounts receivable):
Current ratio = Current assets / Current liabilities
The higher the ratio, the better your liquidity. If it’s greater than 1, you can pay off your current obligations using current assets. Your current liquid assets can’t cover your liabilities if it's lower than that, in which case you might need to consider alternative funding options.
Quick ratio
The quick ratio, sometimes called the acid-test ratio, measures your business's ability to meet short-term obligations using only your most liquid assets. Quick ratios are similar to current ratios, but they exclude inventory and prepaid expenses.:
Quick ratio = (Current assets - Inventory - Prepaid expenses) / Current liabilities
It's important to note that the current ratio can include semi-liquid assets, such as inventory and prepaid expenses, while the quick ratio doesn’t. A quick ratio lower than 1 could indicate insufficient liquid assets. You can’t easily convert those to cover current liabilities.
Why liquid assets matter for a business
Liquidity is crucial when you need funds on short notice. Liquid assets ensure your business has the resources necessary to meet its liabilities or obligations. The more liquid assets your company holds, the more flexible and agile it is.
When something unexpected happens, you may not have time to sell property or valuable equipment. Even if you do, you likely won't recover your entire investment and the true value of the assets.
If a bill must be paid “or else,” non-liquid assets won’t help much. What does help is having liquid funds available as an emergency reserve, enabling you to settle both expected and unexpected bills promptly.
A high ratio or volume of liquid assets also helps when applying for business loans. Excess cash shows you’re creditworthy. And increased access to cash and credit enables you to handle unexpected expenses or market shocks. In addition, higher levels of liquidity provide you with greater business flexibility.
Ramp: Increasing your liquidity
If you run the ratio calculations above and find that your business isn’t as liquid as you’d like it to be, don’t panic.
This is where the Ramp can help. We designed our corporate card to strengthen your finances. Our 30-day payback period can temporarily increase your liquidity, granting you more purchasing power and flexibility.
On top of that, Ramp offers a built-in finance automation platform that analyzes your transactions and identifies saving opportunities for you. Our software gives you increased visibility into your finances, allowing you to track and measure your company's spend and liquidity in real time.
Want to learn more? Get Ramp today.
FAQs
A company's most liquid assets are those that can quickly and easily convert to cash without losing significant value. In addition to cash and cash equivalents, marketable securities, and accounts receivable, some types of inventory can be considered liquid if there’s strong demand for them, but that depends on the nature of the business.
For example, food and beverages are more liquid because they’re easier to sell. Antiques and collectibles are less liquid and don’t turn over very quickly, while fashion retail and seasonal products can fall victim to changing trends and the cruelty of the calendar.
Bulk sales, discounts, and promotions can quickly move inventory, but they can also eat into profit margins. You might also consider inventory financing, which uses your inventory as collateral. Take care not to overvalue your inventory, however. Also, inventory financing tends to carry higher interest rates, and if you don’t hit your sales target on time, you may struggle to repay your loan on schedule.
Yes—higher liquidity may mean your business holds too much cash instead of investing in research and development. You can also run the risk of maintaining high cash reserves instead of paying down high-interest debt, which can lead to higher borrowing costs than necessary.
In addition, you may keep too much money in low-yield savings accounts, money market accounts, or another bank account instead of putting it toward projects with higher potential returns. For these reasons, sound cash and liquidity management are crucial for your business health, as is cash flow management.
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