There is a popular saying in the business world: cash is king.
Cash is the most liquid asset, which is a big reason why it’s king.
Below, you’ll learn all about liquid assets, including:
- The meaning of liquid assets
- Examples of liquid and illiquid assets
- Why liquid assets are important to small businesses
- How to know if your small business has enough liquid assets
- How to build your liquid assets
Let’s get started.
Liquid Assets Definition
A liquid asset is an asset that can easily and quickly be turned into cash at its fair market value.
So, a share of Apple stock is a liquid asset because you can immediately sell at its fair market value. A piece of equipment, on the other hand, is an illiquid asset because you are unlikely to be able to sell the asset for its fair market value in a short period of time.
An asset that is expected to be converted into cash in one year or less, such as inventory, can also be viewed as a liquid asset. But this type of asset is less liquid than cash or a share of a blue chip stock.
Examples of Liquid Assets
Here are five examples of liquid assets, ranked from most liquid to least liquid:
Cash is the definition of a liquid asset since it’s already… well… cash.
2. Cash Equivalents
Cash equivalents are non-cash assets; they share similarities with cash, though.
Treasury bills and money market funds are two types of cash equivalents.
A treasury bill fits the definition of a liquid asset because it can easily and quickly be converted into cash at its fair market value – unless there is a massive crisis.
Stocks are a liquid asset, but less liquid than cash and cash equivalents.
Not all stocks are created equal, though.
While the stock of a huge company like Apple or Microsoft is nearly as liquid as cash, the stock of a small company with a big spread (difference between bid and ask price) is less liquid. If there is a big spread, you may have to sell for a little below fair market value if you want to immediately sell the shares.
4. Accounts Receivable
There is a big drop in liquidity from stocks to accounts receivable.
Here are a few reasons why:
- The credit term may be a couple of weeks… or a couple of months.
- Some clients may not pay on time.
- Some clients may never pay.
Due to the above characteristics of accounts receivable, it’s important to have conservative expectations. Don’t count on 100% of your accounts receivable being collected on time – or ever.
The liquidity of inventory varies not only from business to business, but within a single business – even if there is no recession or slowdown.
For example, a clothing retailer may have one type of inventory that flies off the shelves and another that occasionally sits on the shelves for months or years.
So, evaluate the liquidity of your inventory on a case-by-case basis.
Examples of Illiquid Assets
Let’s look at a couple of examples of illiquid assets:
Selling a piece of property is a long process. You may have to get real estate brokers, banks, and other parties involved – and selling the property at fair market value may still take months or years.
Since you can’t easily sell property, you can’t quickly sell property, and you may have to wait a while to get a good offer, property does not satisfy any part of the definition of liquidity.
A vehicle may be a more liquid asset than a piece of property, but how liquid depends on the type of vehicle. A truck that can only be utilized by a small number of businesses is going to be less liquid than a Honda Civic.
You may be able to sell a vehicle on your own, but it may take a lot of legwork (not easy to convert to cash) and patience (slow to convert to cash) to get fair market value.
Why are Liquid Assets Important to Small Businesses?
Liquid assets are important to small businesses because they are necessary to pay the bills and jump on attractive opportunities.
While operating cash flow allows a small business to satisfy short-term financial obligations during normal times, an economic downturn may cause this source of cash to dry up. In that scenario, liquid assets might save the day.
And during normal times, you may not have enough operating cash flow to invest in your business.
For example, you have $10,000 in operating cash flow per month. You are approached by an external provider about the possibility of a $30,000 marketing campaign. You believe the campaign can bring you a 200% ROI. The presence of liquid assets on your balance sheet would allow you to jump on this opportunity.
Does Your Small Business Have Enough Liquid Assets?
You may be wondering:
How do I know if my small business has enough liquid assets?
You can start by calculating your liquidity ratios, such as current ratio and cash ratio. Take the results and compare them to industry averages.
In addition, consider future needs and expectations. For example, a small business owner who wants to make a large purchase in the near future and expects a slowdown in sales may want to accumulate liquid assets.
How to Build Your Liquid Assets
Let’s look at a few ways to build your liquid assets:
- Increase operating cash flow: by boosting revenue and/or cutting unnecessary expenses, you can increase your operating cash flow – which increases the available cash for your small business.
- Increase salary slower than profits: if your profits increase by 20% year-over-year (yoy), it’s tempting to increase your salary by 20%, as well. If you increase your salary by a lower percentage, however, you can build your liquid assets and take home more money.
- Make savvy investments: if you don’t need some of your cash for a period of time, investing in stocks or bonds gives you a chance to build your liquid assets. With that said, this option brings the possibility of losing money – so you might want to talk to a professional first.
- Finance assets (when appropriate): let’s say you decide that buying a new company vehicle is necessary to grow your small business. In this case, you may want to consider financing the vehicle – so you don’t have to exhaust a large percentage of your liquid assets.
The Bottom Line
Having liquid assets available is crucial to the long-term success of a small business.
So, what do you do if you don’t have enough liquid assets on your balance sheet?
In the long-run, the recommendations in the previous section can help you build your liquid assets.
But in the short-term, consider using Gravity Capital. We provide quick and easy funding solutions for merchants. Learn more about how Gravity Capital works.