What Is a Liquid Asset and How Can It Affect My Small Business?
You’ve probably heard the term “liquid asset” thrown around when discussing business. But what does it mean exactly? What separates a liquid asset from a non-liquid asset, and how does that affect the stability of a business?
Understanding liquid assets is more than just good for bookkeeping — it’s important to understand how healthy a small business is and how prepared one is in the event of an emergency. It’s also a helpful concept to understand for your personal finance.
In this article, we’ll look at liquid assets and then compare them to fixed assets. We’ll discuss briefly how they contribute to a business valuation and provide some real-life examples of liquid and fixed assets. Finally, we’ll look at how liquid assets apply to personal finance.
What Is a Liquid Asset?
A “liquid asset” is either cash or an asset than can easily be converted into cash. It’s a helpful concept because it allows businesses to show how much cash they can get quickly. It’s more of a catch-all term — while a business might not have a ton of actual cash in an account, they might have a lot of assets that can be converted into spendable money in the short-term. So in that sense, they are “liquid,” even if they don’t have much cash in an account.
To figure out if an asset is liquid requires a few considerations.
Some assets, like cash, are inherently liquid. For other assets, however, you must also take into account if there is an established market for the asset and plenty of buyers ready to purchase it quickly.
Stocks are considered a liquid asset because there is an established market for buying and selling stocks and plenty of buyers participating in the stock market, who are available to buy assets whenever the trading floor is open. Fixed assets don’t usually have as established markets. (More on that in the next section.)
More liquid assets often mean more peace of mind for a business owner, as a company with a lot of liquid assets has the ability to react quickly to an emergency situation and get the cash needed to stay afloat. For this very reason, a company with a high “liquidity ratio” — the amount of its liquid assets compared to its non-liquid or fixed assets — is usually considered more healthy than a company with all its capital tied up in assets that are hard to convert into cash.
Liquid Assets vs. Fixed Assets
While liquid assets can easily be converted into cash, fixed assets, or non-liquid assets, are often difficult (or impossible) to convert into cash quickly.
Fixed assets are usually with a company for a long time. This is why liquid and fixed assets are sometimes referred to as “current assets” and “non-current assets,” respectively. Fixed or non-current assets are expected to be on a company’s books for more than a year.
Fixed assets are usually physical assets, or “tangible assets.” They have a physical form, like a building or a piece of machinery. (These are different than “intangible assets” which do not have a physical form.) They are typically reported on the balance sheet as PP&E, which stands for property, plant, and equipment.
A business’s real estate acquisitions would be considered a fixed asset, as would a piece of expensive equipment. While converting these assets to cash is possible, those transactions would often take much more time than an asset considered “liquid.”
That being said, fixed assets can sometimes be used as collateral to secure a loan and get more spendable capital.
Identifying Assets Correctly
Counting liquid assets and fixed assets correctly in a company’s financial statement is vital, as it helps paint a clear picture of the health of a business, much like a cash flow statement or revenue projection can.
For example, say a company buys an expensive piece of computer equipment. The company might be tempted to suggest that there is a strong secondary market for computers like this and that they’ll be able to sell it quickly, making the argument that it should count as a liquid asset.
It would be considered extremely iffy financial accounting to do this, however, especially if they tried to count the full purchase price as part of a company’s assets. There is not really a robust market for used, specialty computers, and used equipment most likely wouldn’t fetch an original sale price on the secondary market. Sound financial analysis would suggest counting that as a fixed asset and look into find its current market value as an accurate reflection of its worth.
Real-Life Examples of Liquid Assets and Fixed Assets
Liquid investments or assets are things that are either cash or easily changeable into cash. For a business, these are sometimes referred to as “marketable securities” — securities that can be sold quickly, usually ones a company plans to sell within a year. This can include stocks, government bonds, treasury bills, or anything with a set market price and buyers ready to buy the asset.
Meanwhile, think of fixed assets as hard to move. This can apply either physically or financially. Big things like office equipment, expensive machinery needed for business operations, or offices themselves are fixed assets. They can’t be moved or sold easily, and will likely be with the business for a long time.
It’s helpful to consider an emergency scenario. Imagine you run a small ice cream shop as a business and your revenue drops severely one month. If you needed to get out serious cash by the end of the week to keep the shop open, would you be able to sell an asset to make that cash? If you had cash on hand, that’s already available to use, so it’s liquid. If you had some stocks in an account and wanted to sell them to cash out by the next day, that’s possible, and thus, that’s liquid, too.
Trying to sell your frozen yogurt machine and get full value for it? That might be hard to do in a day. A machine like that would be considered a fixed asset.
Personal Finance Implications of Liquid and Fixed Assets
Understanding liquid and fixed assets isn’t just important for the health of a business, it’s also important to hitting financial goals in your personal life. In personal finance, being less liquid makes you more vulnerable to a financial emergency, whether it be a health emergency or a major expense you weren’t expecting.
In personal finance, bank accounts tend to be considered liquid assets. This includes savings accounts, which may have minimum balance requirements and aren’t meant to be touched often, unlike checking accounts. That being said, most bank accounts can be easily converted to cash if needed, whether they’re checking or savings. They should be considered liquid assets because of this.
Even 401(k)s or other retirement accounts can be considered liquid assets because, in a true emergency, they can be converted to cash. (We recommend not doing this if you can afford it, however!)
Fixed assets in personal finance also apply to large things that can’t be converted to cash easily: real estate, cars, expensive equipment, etc. If you buy a home, that may help pad your net worth, but selling a home is a long process. There is a real estate market, of course, but listing a home, finding a buyer, getting a home inspected, and then closing the deal is an involved, often lengthy process. Because of this, real estate is almost always counted as a fixed asset.
People without many liquid assets may have to take on debt to deal with an emergency, putting expenses on credit cards with high interest rates or taking out a second mortgage to handle the problem.
While people often won’t conduct a liquidity ratio calculation like a business might, it’s still helpful to have a good understanding of money you can access in the event of an emergency. And it’s often a good idea to not have too much of your net worth tied up in fixed assets.
Understanding Liquid Assets and Fixed Assets
Understanding liquid assets and fixed assets is important not only to having a clean balance sheet — it’s vitally important for a healthy financial life. The economic benefits of having healthy liquidity are hard to understate and can often make the difference when it comes to being able to handle a financial emergency.
By reading this article, you should have a deeper understanding of liquid assets and fixed assets and how maintaining a good balance between the two can give you peace of mind moving forward.