What are liquid assets? Why they're critical for businesses

There are plenty of financial terms that sound more complicated than they really are. For instance, asset liquidity may seem like an industry buzzword, but the definition is actually very simple. Liquidity refers to how rapidly an asset can be converted into cash, with cash being the most liquid asset.

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fThe more “liquid” an asset is, the easier it is to convert into cash in hand when necessary. Liquid assets can help small business owners calculate their net worth and do financial planning. Liquid assets are also recorded on a company’s balance sheet.

Liquid assets are a critical part of your business’s financial profile.

What are liquid assets?

In terms of the value they hold, think of liquid assets as cash. They’re a type of asset that can quickly be converted to cash without losing market value. They’re great for businesses to have because of the flexibility they offer and their ability to respond to market shocks or pay off debts. And when it comes to the financial statements of your business, they’re considered cash equivalent

Here are some examples of liquid assets:

• Cash: This is the most liquid asset, since cash on hand is the most flexible form of payment.
• Checking or savings accounts and certificates of deposit: Funds sent to a bank account (e.g. savings or checking account) can be accessed practically anywhere and at any time. 
• Accounts receivable: The money owed to your business for services or goods rendered already would also be considered a liquid asset. ‍
• Certain investments like marketable securities, stocks, bonds, mutual funds, and money market funds: Because there is a large stock market of ready-to-buy investors at any point in time, these types of investments can often be sold on short notice without losing significant value and are thus considered liquid investments.

The opposite of a liquid asset is called a non-liquid asset. These are assets that can’t be converted to cash quickly and easily or without the risk of losing value. Real estate holdings that can take time to sell and retirement accounts, which may incur penalties for an early withdrawal, are two examples of non-liquid assets.

As a business owner, it’s critical that you know the total value of your liquid asset portfolio. This information lets you gauge how much cash you could quickly access should a financial emergency occur or if your cash flow forecastinging was off. If you were to find yourself in need of quick cash, it would likely be easier and less expensive to access your own liquid assets. During a liquidity crunch, loans are harder to obtain and businesses tend to get charged high-interest rates by lenders. These conditions could raise the risk of potential business failure or significant debt.

What are liquidity ratios? 

Liquidity ratios are a critical way for business owners to measure and monitor your ability to pay off current debt obligations without seeking outside financial assistance. 

These ratios measure your current liabilities (non-liquid assets) weighted in relation to your liquid assets. Liquidity ratios allow you to see how much short-term debt you can manage should a financial emergency occur.

There are multiple types of liquidity ratios but two of the most common at the current ratio and the quick ratio.

Current ratio

Current ratio = current assets ÷ current liabilities

The current ratio measures your business’s ability to pay off current liability within a year using current business assets, like cash, and semi-liquid assets like inventory and accounts receivable. The higher the ratio, the better your liquidity. If your current ratio is greater than 1, it means you can pay off current obligations using current assets. If it’s lower than 1, it means that your current liquid assets are not enough to cover the liabilities and you might need to consider alternative funding options.

Quick ratio

Quick ratio = (current assets - inventory - prepaid expenses) ÷ current liabilities.

Quick ratio, also sometimes called the acid test ratio, measures your business’ ability to handle short-term obligations using only the most liquid assets. Remember, the current ratio might include semi-liquid assets like inventory and prepaid expenses, but the quick ratio doesn’t. A quick ratio lower than 1 could indicate insufficient liquid assets. Quick ratios are similar to a current ratio, except for the fact that they ignore inventory and prepaid expenses since those cannot be redeemed easily to cover current liabilities.

Utilizing these liquidity ratios give both your finance team and investors an idea of whether your company is properly managing its working capital and will be able to pay off bills as they arise. It gives the full picture of where your business stands with and without semi-liquid assets.

Why liquid assets matter for a business 

Liquidity matters in case unexpected financial situations come up and you need funds on short notice. Liquid assets ensure that your business has the resources necessary to satisfy your liabilities or obligations. The more liquid assets your company holds, the more flexible and agile your business is.

When something unexpected happens, you may not have time to go through the drawn-out process of putting property or valuable equipment up for sale. Even if you do, you likely don't get your full investment and the full worth of the assets back. 

If you run into a situation where a bill needs to be paid “or else,” non-liquid assets won’t be of much help to you. What is helpful though is having liquid funds to act as a emergency fund, making it possible to immediately pay off both the expected and unexpected bills. 

A high ratio or volume of liquid assets is also helpful if you find yourself applying for business loans. Excess cash on hand demonstrates that you’re more creditworthy. And when you have increased access to cash and credit, you’re able to weather an unexpected expense or a market shock. Plus those higher levels of liquidity lead to 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. 

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This is where the Ramp can help. We provide a corporate card that is designed to strengthen your finances. Our 30-day payback period can temporarily increase your liquidity, granting you more purchasing power and flexibility.

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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. 

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Want to learn more? Get Ramp today.