What are liquid assets and why are they important?

Liquidity indicates how easily you can access and move your money. Businesses with high liquidity can handle unexpected changes, such as having to settle a large cash payment at short notice.

Banks and financial institutions use liquidity to judge a company’s credit score. Maintaining high liquidity means a good credit score, which can get you favourable interest rates and loan terms.

Here, we’ll look at what liquid and non-liquid assets are, and explain how you can use liquidity ratios to measure your business’ liquidity.

What is liquidity?

Liquidity refers to your business’ ability to convert assets into cash. Imagine cash flow as water from a tap — when you turn on the tap, how much water flows out, and how fast? ‌The volume and speed of your tap water is your measure of liquidity.

As a business, your money is typically held in your assets. To determine your business' liquidity, you look at two types of assets: liquid and non-liquid.

What are liquid assets?

A liquid asset is any type of asset your business holds that can be quickly converted into cash without losing its market value.

Several factors can affect an asset’s liquidity, such as:

• How long it takes to sell the asset

• How easy it is to transfer ownership of the asset

• Whether there's a market for selling that asset

Types of liquid assets: cash and non-cash

Cash assets are any type of asset that involves actual currency.

Some examples of cash assets include:

• Cash: Cold, hard cash is one of the most liquid cash assets available. It’s available on demand, holds its market value well, and can be easily transferred.

• Bank deposits: Cash balances can be withdrawn from your bank account without currency conversion. Withdrawal is quick, easy, and accessible.

• Accounts receivable: This is money that your customers or suppliers need to pay you — how liquid it is depends on whether they pay you on time.

Non-cash assets are still highly liquid, but less so than cash assets. One example is cash equivalents, which includes stocks, bonds, and exchange-traded funds (ETFs).

For example, you can usually sell publicly-traded stocks for cash within a few days. Other investments, such as fixed-term deposits, are less liquid, even though they might also invest in the stock market.

What are non-liquid assets?

A non-liquid or illiquid asset is an asset that's harder to convert into cash.

To cash out non-liquid assets, you’ll have to either sell them or transfer ownership. This process isn’t always straightforward and usually takes some time – be it to find the right buyer, negotiate for a favourable contract value, or deliver contractual obligations.

Non-liquid assets include:

• Real estate: Selling real estate typically involves several stages, including property appraisal, market analysis, listing, negotiations, and finally closing the sale. Each step can be time-consuming and can vary widely depending on market conditions.

• Vehicles and business equipment: The value of these assets may depreciate over time, and finding buyers can be challenging without significant price reductions. Selling them often requires time for advertising, negotiations, and finalising terms that meet regulatory compliance.

• Art, jewellery, and collectibles: The market for these items is highly specialised. Their value can be extremely subjective, depending on current trends, historical significance, and individual collector interest. Liquidation can take a long time and may not always yield the anticipated return.

• Ownership in non-publicly-traded businesses: Shares in private companies are often subject to contractual restrictions that limit selling opportunities. The lack of a public trading venue can make finding an interested buyer difficult, and legal complexities can prolong the sale process.

Why are liquid assets important?

Liquid assets provide you with cash when your business needs it. This cash could cover operational costs such as supplier invoices, employee wages, insurance payments, and ongoing bills.

More importantly, liquid assets are invaluable in providing a safety buffer. If you need to make an urgent purchase or pay an unexpected bill, having a reserve of liquid assets as part of your emergency fund can save your business.

The higher the volume of liquid assets your business holds, the more prepared you are for operating flexibly.

A high volume of liquid assets also benefits you when applying for loans, as high cash availability makes you a lower-risk loan candidate. You may even be able to access more competitive interest rates and better loan terms, which is crucial for startups and new businesses.

What are liquidity ratios?

Liquidity ratio is a metric that compares liquid assets to current liabilities. Businesses use this metric to assess whether they can handle short-term financial liabilities independently. Of the different liquidity ratios available, the current and quick ratios are most commonly used.

The current ratio evaluates your ability to settle your business’ short-term liabilities with its short-term assets, usually within a year. The formula is:

Current assets / Current liabilities = Current ratio

A current ratio above one shows that a business has more than enough liquid assets to cover its current liabilities, while a ratio below one suggests otherwise.

The quick ratio – also known as the acid-test ratio – assesses your ability to meet short-term obligations with your most liquid assets. It's a more specific metric as it excludes less liquid assets from the calculation, such as inventory and prepaid expenses. The formula is:

(Current assets - Inventory - Prepaid expenses) / Current liabilities = Quick ratio

Both ratios offer critical insights into your business’ financial health. This information can help your finance team and investors assess if your business can sustain its working capital and meet upcoming financial obligations.

Where should you keep your liquid assets?

Liquid assets are crucial for your business. They help to pay for short-term expenses and provide a cash buffer for emergencies. Popular options for keeping your liquid assets include high-interest bank savings accounts and yield-generating cash management accounts. These options let you access cash quickly with minimal risk at short notice.

For all other cash you'd need for your immediate to short-term expenses, consider keeping it in a multi-currency account that lets you hold and pay out in different currencies quickly. Airwallex’s Business Account does just that, helping you to save more by eliminating unnecessary conversion and transaction fees.