Cash is assets that your business can quickly convert into cash. This type of asset can help you deal with business emergencies or cash flow problems because it provides you with quick cash flow that you can use to pay for your business expenses. If you’re wondering what a liquid asset is and how to use it for your business, this article will walk you through what you need to know.
What is a liquid asset?
A liquid asset is something of value that you can turn into cash quickly and easily. Besides the obvious cold hard cash option, marketable securities like common stocks and bonds are also good liquid assets. As a business owner, tracking your cash flow can help you determine the financial health of your business and your ability to pay your debts.
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
- Retain its value when converted to cash
When accounting for your small business, your assets are divided into current and long-term assets, and these further break down on a liquidity scale. All liquid assets are listed under the current assets line of your balance sheet. Companies can qualify an asset as liquid if it takes less than a year to convert it into cash. Your company’s inventory and accounts receivable are current assets that would be considered liquid because they can be transferred to cash within a year.
A company’s liquidity shows that its cash flow is sufficient to repay all its short-term commitments. Cash and securities are the most liquid because they are the most easily usable. Assets that are not easily converted into cash are called illiquid or illiquid assets. Some assets may not be convertible into cash at all.
But don’t give up illiquid assets altogether. In fact, it’s important for your business to maintain a mix of liquid and illiquid assets. One reason: liquid assets do not grow as steadily as illiquid assets. The less accessible an asset is, the higher the interest rate and the more likely it will yield. For example, a real estate investment is an illiquid asset, but its value can increase much 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 run out of money more easily than illiquid assets. Let’s say you need to increase your inventory and have a good amount of money in your business checking account. You may be able to withdraw from this account instantly to cover costs until you can pay some of your bills.
Examples of Liquid Assets
Assets are also not liquid. Money is the most liquid of all assets because it is already the end goal. The definition of “cash” includes undeposited notes, coins and checks, as well as anything deposited in a checking or savings account.
Cash equivalents such as US Treasury bills, certificates of deposit that mature in one year or less, commercial paper and bankers’ acceptances are also highly liquid. Other types of assets like stocks, bonds, money market assets, mutual funds, and exchange-traded funds (ETFs) are also considered liquid. Your accounts receivable and inventory are also considered liquid.
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 are not publicly traded). stock Exchange). Accounts that charge you for early withdrawals are also less liquid than others.
Liquidity of your financial accounts
It is useful to understand your business liquidity in case you need to use your cash to solve short-term cash flow problems.
Financial analysts commonly use two ratios to examine the liquidity of a company’s accounts: the current ratio and the quick ratio. The current ratio compares current assets to current liabilities to decide if you are ready for trouble. The quick ratio assesses whether the company would be able to manage its current liabilities with only its liquid assets. Consult a finance professional if you have questions about calculating your business’s cash flow.
Here is a breakdown of the liquidity levels of each of the bank accounts your business may have:
- Verify Accounts: Business checking accounts are the most liquid of all business accounts because they are the most like cash. Checking accounts allow you to pay directly from the account using a debit card or check. Additionally, you can use an ATM to withdraw money instantly without the money losing value.
- Savings accounts: Business savings accounts have more restrictions than checking accounts and limit the number of times you can withdraw per month (usually about six times at most). Your savings account is therefore a little less liquid because it is more difficult to withdraw money.
- Money market accounts: Money market accounts are like a cross between a checking account and a savings account, and they limit how often you can withdraw your money. They are about the same in terms of liquidity as a savings account.
- Cash management accounts: Cash management accounts are like checking or savings accounts offered by a non-bank entity, such as a robo-advisor or brokerage firm. These accounts often do not limit the number of 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 are quite liquid, depending on the account. You can sell the assets and receive cash quickly, but selling on the exchange also means that you may sell when the value is low, which hurts liquidity a bit.
- Tax-advantaged accounts: Think of a retirement account like a 401k, an IRA, and an HSA. These are less liquid as you will have to 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 easily accessible than others, and therefore less liquid.
What liquid assets mean for small businesses
The more liquid assets you have, the more you will be able to pay your debts. This is why lenders ask for your bank statements before offering you a loan. These assets contribute to the overall net worth of your business, so you will seem less risky. Lenders want to know that you have emergency funds ready in case your business runs into trouble.
As a business owner, it’s important to manage the money you have so you can pay your bills and buy needed items. Some industries, like banking, even regulate how much a company must keep.
But if you’re not comfortable dipping into your emergency fund, consider a small business loan or business credit card. Small business loans give you working capital that you can use to pay business expenses at an interest rate that may be lower than a business credit card. Sign up with Nav to be matched with your loan options today.
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