What is a Liquid Asset: Detailed Overview

You may own real estate, a sizable car fleet, antiques, or other assets of high financial value. All of these surely have their uses and indicate the stable financial position of your business or you as an individual. However, all of these may prove completely useless in an emergency. After all, selling these assets is a complex and time-consuming process. In this case, only money or assets that can be quickly converted into it — so-called liquid assets — will matter.

Want to learn more about what is considered a liquid asset? Unsure how to address a low liquidity ratio? Afraid of facing potential risks? Keep reading, and you’ll learn how to make liquid assets work for your financial stability.

What Is a Liquid Asset?

The definition of liquid assets is as follows: any type of asset that can be converted into cash within a short period.

Other characteristics of liquid assets include:

• Low transaction costs. Converting liquid assets is inexpensive or involves minimal fees.
• Ease of transfer. Ownership rights can be transferred with minimal effort.
• Established market presence. Liquid assets are typically traded on major markets, and both sellers and buyers are readily available. Public exchanges for stocks and bonds are a good example of what we’re talking about.
• Price volatility. External factors, such as inflation, market volatility, currency risks, and more, usually influence the value of liquid assets.

One of the most apparent liquid asset examples is cash. However, there are other options.

Examples of a Liquid Asset

Cash and Its Equivalents

In this context, cash refers not only to physical money (coins and banknotes) but also to funds stored in checking and savings accounts in financial institutions. These equivalents are just as good for ensuring a high liquidity ratio as physical cash.

Cash equivalents also include:

• Treasury Bills (T-Bills) — short-term government securities. They are highly liquid because they can be quickly sold on the market.
• Certificates of Deposit (CDs) — a type of savings account that offers higher interest rates in exchange for reduced access to funds. However, a CD opened for 3–6 months is considered only relatively liquid.
• Money market funds — short-term investment instruments that provide a higher return than savings accounts.

Marketable Securities

A marketable security is any debt or equity instrument that can be easily and quickly converted into cash.

Among others, they include:

• Stocks — securities of publicly traded companies that can be sold on the stock exchange at any moment.
• Bonds — government or corporate debt instruments traded on the over-the-counter market.
• Exchange-Traded Funds (ETFs) — funds that hold various securities traded on stock exchanges.

Inventory

While not the most liquid type of investment, a company’s inventory can usually be converted into money fairly quickly.

So, what can be considered a part of an inventory?

• Finished goods — all produced items ready for sale.
• Raw materials — materials used for producing finished goods, which can be quickly sold or used for their intended purpose.
• Work-in-progress — semifinished goods in the process of being produced.

Accounts Receivable

This rather unusual liquid asset example is nonetheless a functional alternative to cash. Account Receivable is the money owed to a company for goods or services delivered. It can be classified as liquid, as accounts receivable are usually collected within 30–60 days. Moreover, they can always be sold or refinanced through factoring.

There's two types of assets in this class:

• Unpaid invoices — money owed by clients for the delivered goods or services.
• Notes receivable — written payment obligations that can be exchanged for cash when the payment is due.

As you can see, there are quite a few liquid assets out there. Technically, any asset that can be quickly converted into cash without losing market value can be considered liquid.

How to Grow Liquid Assets

Any company requires at least some liquid assets to function, as all legal entities have short-term financial obligations that require cash to meet. Moreover, having liquid assets in store ensures that a business is prepared for unforeseen expenses.

There are several steps you can take to maintain a sufficient level of liquid assets:

Step #1. Control cash flow. Modern automated cash flow management tools make this task relatively easy.

Step #2. Create an emergency fund. This fund will allow your business to weather financial crises without resorting to loans or other external funding sources.

Step #3. Choose the most profitable and liquid investments. Free cash that simply sits in a checking account without earning interest can be usually put to better use. Invest in money market funds or securities.

Step #4. Optimize inventory management. Excess inventory hinders the release of cash. Therefore, it is advisable to check inventory turnover ratios, sell stagnant products at discounts, and implement a Just-In-Time (JIT) inventory management system.

Step #5. Diversify liquid assets. Keeping all of your liquid assets in one account is not a good idea. It is better to store some of your assets in cash equivalents and marketable securities. You can also consider selling or factoring accounts receivables.

These steps will help you increase the liquid assets of your business, making sure its daily operational needs are covered and improving its ability to withstand financial difficulties.

Advantages and Risks of Liquid Assets

The concept of liquid assets, the meaning of which we’ve discussed earlier, is far from a new one. Both businesses and individuals have long utilized them for:

• Quick access to cash. This allows a company to meet urgent financial needs.
• Easy management. You can easily track account balances and maintain control over the liquidity ratio.
• Support for creditworthiness. Availability of liquid assets can increase creditors' trust in a company, as it signifies the business's ability to cover debts. This can play a key role in attracting additional financing.

However, there are also some risks traditionally associated with liquid assets:

• Low or zero return. Flexibility in withdrawing money usually means low profitability.
• The impact of inflation and other external factors. The value of a liquid asset can fluctuate depending on external factors you have no control over.
• Risk of missed opportunities. Keeping a large portion of assets in savings accounts with minimal interest rates is far less profitable than, say, investing in non-liquid assets with higher returns.

When developing your investment strategy, always try to maintain a healthy balance between liquid and non-liquid assets.

Final Thoughts

Liquid assets are all assets that can be quickly converted into cash without reducing their value. What are examples of liquid assets? These include physical money, cash equivalents, marketable securities, and other short-term investment and debt instruments.

They are essential for any business, as they allow a company to meet its short-term financial obligations and maintain its credibility in the eyes of partners, investors, and creditors.