While financial jargon is not everyone’s specialty, there is one concept that is crucial for everyone to understand in order to maintain financial security: liquid capital. Liquid capital consists of the money or convertible assets that are readily available to you, allowing you to live with economic security in the face of any monetary or stock crisis. What is liquid capital (and illiquid capital)? How do you acquire it? And how can liquid capital be of value in your life or business?
What is Liquid Capital?
Liquid capital is an asset that is considered easily convertible, such as money or something that can be quickly converted into money. It is also known as fluid capital, quick assets, liquid assets, and realizable assets. Understanding liquid capital is easier when you understand what liquid capital is not: a long-term or fixed asset, such as a home, a property, or a business. On the other hand, money that you have in the bank or on-hand is considered liquid capital.
What Does Liquid Capital Mean?
Liquid capital is considered “liquid” since it is able to be fluidly converted into cash. Illiquid assets, on the other hand, are not easily turned into money or take a longer time to be converted into cash. Liquid capital makes up half of a person’s net worth, with the other half belonging to their long-term assets. In most cases, the combination of liquid assets and illiquid assets is essential for any individual to maintain financial wellbeing.
How Do You Get Liquid Capital?
Liquid capital has many functions in addition to putting money in your pocket. Understanding your liquid assets is essential for those who hope to navigate business careers as a profession. Having a well-versed knowledge of your personal liquid capital is important to keep confidence that any business/investment/economic emergencies that you encounter will not tank your financial stability. With non-liquid assets such as properties and real estate being susceptible to losses in the event of economic emergencies (such as the 2008 stock market crash), liquid assets provide an increased level of financial security.
Additionally, liquid capital is often a requirement when building a business. For entrepreneurs, liquid capital is typically mandatory by organizations and businesses if you are planning on entering into an investment or opening your own franchise. Liquid capital guarantees that you will be able to meet investment/business costs without needing to rely on excessive external loans or without the business crashing during times of low interaction or economic crisis. Having a comprehension of your liquid assets will not only help you open your own business but also navigate it during financially tumultuous times.
Liquid Capital Examples
In addition to cash, there are many different forms of liquid capital that you can contribute to your overall fluid assets. These include:
- Banking accounts: Savings and checking accounts that include cash funds, as well as money-market accounts (investment-based savings accounts).
- Retirement accounts: 401k and IRA accounts, as well as any other retirement-centered accounts.
- Mutual funds: Collective of investors with money that is combined into a pool of funds.
- Paid expenses: Personal expenses that have been paid before their required payment dates, such as rent, electric, and house/car insurance bills.
- Savings bonds/treasury bills: A bond/bill that must mature before being worth its full value, but is guaranteed to achieve a certain value at its maturity date.
- Stock accounts: Shares of any stock that are under your ownership.
It’s also important to consider that liquid assets only remain liquid so long as there is a market for them. Any asset that can be easily converted to cash within a market without the price of that item changing by its inclusion into the market is considered liquid. However, if an asset would negatively affect the value of similar products when added into a market setting, then it is not considered liquid. The largest setting of the movement of liquid capital is the foreign exchange market, which sees the passing of trillions of dollars and liquid assets daily.
Calculating Liquid Capital
Now that we’ve learned about liquid capital, let’s examine the flip side: illiquid assets. Illiquid assets are anything that cannot be easily/quickly converted into cash or something that cannot be converted quickly without losing its value. Illiquid assets often don’t develop any public value until the process of selling that asset is underway, such as in the case of a home or a vehicle. Illiquid assets that cannot be easily transferred into hard cash include items like real estate, land, cars, collectible items, and artwork. Business inventory is also considered illiquid unless a business owner believes that the stock will meet its profit margins within the year that the inventory is received. Essentially, restricted cash that is invested in long-term assets is not considered liquid.
Most people require a balance of liquid and illiquid assets. Having liquid assets and cash in the bank is useful for anyone’s financial security, yet housing, health insurance, and other illiquid assets are also essential to lead a sustainable life. This balance is also crucial for those who are attempting to manage their own business pursuits. Ultimately, businesses require liquid assets in order to develop financial security, including petty cash and emergency funds. However, businesses must also invest in illiquid assets, such as insurance and office space, in order to keep their businesses running. Understanding this balance and ensuring that you are covered on both ends can regulate the difference between financial success and economic instability.