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. The more “liquid” an asset is, the easier it will be to gain access to that money in a time of need. Liquid assets can help small business owners calculate their net worth and are also recorded on a company’s balance sheet.
Liquid assets are a critical part of your business’ financial profile. In this brief financial planning article, we’ll cover:
What are liquid assets?
Liquid assets are a type of asset that can quickly be converted to cash without losing market value. They offer businesses flexibility and the ability to respond to market shocks or pay off debts. These assets are considered cash equivalents on a business’ financial statements.
Here are some examples of liquid assets:
- Cash – Legal tender is the most liquid an asset can be, since cash on hand is the most flexible form of payment.
- Checking or savings accounts – Funds sent to a bank account (e.g. savings or checking account) can be accessed practically anywhere and at any time.
- Certain investments (marketable securities, stocks, bonds, mutual funds, 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.
Liquid assets are essentially the opposite of non-liquid assets, which cannot be converted to cash as quickly. Examples of non-liquid assets include real estate holdings that can take time to sell or retirement accounts, such as an IRA, which may incur penalties for an early withdrawal.
It’s critical that you know the total value of your liquid asset portfolio. Knowing this lets you gauge how much cash you could quickly access should a financial emergency occur. During a liquidity crunch, loans are harder to obtain and businesses tend to get charged high-interest rates—raising the risk of business failure.
What are liquidity ratios?
Liquidity ratios are a critical way to measure and monitor your ability to pay off current debt obligations without seeking outside financial assistance. These ratios measure your current liabilities weighted (illiquid assets) 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.
Common liquidity ratios are:
Current ratio = current assets ÷ current liabilities. This measures your business’ ability to pay off current liability within a year using its current assets, like cash, inventory, and accounts receivable. The higher the ratio, the better your liquidity. If your current ratio is greater than 1, you can pay off current obligations using current assets.
Quick ratio = (current assets - inventory - prepaid expenses) ÷ current liabilities. This measures your business’ ability to handle short-term obligations using only the most liquid assets. While the current ratio might include semi-liquid assets like inventory and prepaid expenses, the quick ratio doesn’t. A low quick ratio could indicate an inadequate amount of 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.
Why liquid assets matter for a business
Liquidity matters in cases where a financial crisis arises. Put simply, liquid assets ensure that your business has the cash resources necessary to satisfy any liabilities or obligations that are due. They help you prepare for a rainy day; the higher the volume of liquid assets your company holds, the more flexible and agile the business will be.
When something unexpected happens, you need to have cash on hand that’s readily accessible. If debts are called, you can’t go through the drawn out process of putting property or valuable equipment up for sale, especially since you may not get fair value due to the rush.
According to tax expert, Jay Way: “A company keeps a certain amount of liquid assets in place for the purpose of meeting short-term obligations. These are current liabilities that come due within a year and can be met timely only with liquid assets, due to their immediate convertibility to cash.”
If you run into a situation where a bill needs to be paid “or else,” non liquid assets can’t help you get out of this crunch. What is helpful is having liquid funds acting as a financial safety buffer, making it possible to immediately pay off both the expected and unexpected bills.
A high volume of liquid assets is also helpful for applying for loans. By having excess cash at your disposal, you demonstrate 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. Higher levels of liquidity lead to greater business flexibility.
Ramp: Increasing your liquidity
So, what do you do if you run some calculations and realize that your business is not as liquid as your business needs to be?
This is where the Ramp can help. The Ramp card is a corporate card program built 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 1.5% cash back on every purchase and a built-in automated accounting platform that identifies saving opportunities for you. This powerful system 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.
The term liquid assets is defined in our Ramp Finance Glossary.