Understanding What Liquid Capital Is and Why It’s Important

Although liquid capital is one of the most important factors when calculating net worth, the average consumer often misunderstands what it is and how it works. It is often thought to be a term associated with businesses that refers to moving money around quickly.

In this article, we’ll examine liquid capital, how it differs from other forms of capital, and why it is important not only in business but also in personal financial affairs. 

What Is Liquid Capital?

Understanding liquid capital is fairly straightforward: it refers to any asset or cash equivalent that can be quickly converted into cash without losing a significant amount of its value and without difficulty. This means there is an open market in which the asset is in demand, and there are no stringent regulatory requirements to fulfill to sell the asset.

Examples of Liquid Capital

Liquid capital can take many forms. The most common is cash or cash equivalents, which are assets like money market accounts, treasury bills, and some marketable securities that can be sold quickly.

Other forms of liquid capital include public stocks and bonds that can be sold on an active exchange and certificates of deposit that feature short-term maturities. 

Characteristics of Liquid Capital

Assets need to check certain boxes to be considered liquid capital. While it’s not necessary to meet all the requirements below, the more that are met, the more liquid an asset is.

Easy Conversion

An asset can only be considered liquid capital if it can easily be converted into cash. This should occur quickly, usually within a few days.

Stable Value

Alongside being easy to convert to cash, an asset is only liquid if it can be sold without losing its marketable value. Any asset that loses a significant portion of its value due to being sold quickly is commonly not considered liquid as its real value is not being accounted for.

Demand

For an asset to be liquid, there needs to exist a demand for it that will allow the sale to proceed quickly. Commonly, this means there needs to be an established market where the asset can be sold and demand is met.

Cost

Apart from retaining their value when sold, liquid capital assets are defined by their ability to avoid excessive fees and costs. Any asset that incurs high fees is generally not considered liquid, as much of the cash the asset is sold for could be used to cover the fees associated with selling it. 

Legality

The final characteristic of liquid assets is that they do not attract any regulatory obstacles during their sale. Only assets that avoid significant legal barriers to the transfer of ownership can be considered liquid.

Other Forms of Capital

Although liquid capital is generally the most important factor when calculating true wealth and worth, other forms of capital are also usually referenced. These operate differently from liquid capital despite often being confused for it.

Working Capital

Working capital can, in some cases, include liquid capital and assets, particularly because it refers to the day-to-day capital required to run a business or keep personal finances in order. One of the most common examples of working capital is trading inventory and accounts receivable, which aren’t liquid in nature but can add up to large cash sums should they be sold.

Fixed Capital

True to its name, fixed capital refers to assets often invested for extended periods, making them a fixture in a company or personal capacity with no short-term plans to become liquid. Examples include plant, equipment, and property, which are not as easily converted into cash.

Illiquid Capital

The final type of capital related to business and personal use is illiquid capital. Assets under this category that cannot easily be converted into cash or will lose a significant amount of their worth when converted. Examples are properties, collectible items or antiques, and any other asset that may not have a large selling market or high demand.

The Importance of Liquid Capital

Once liquid capital is understood, knowing why it is so important to business and private financial affairs is essential. For personal finances, there are two main reasons why having liquid capital available is important. 

Emergencies

One of the most important roles that liquid capital plays in personal finance is as a buffer for financial distress or emergencies. These can occur due to unexpected medical bills, unforeseen job losses, or even events like car breakdowns. 

Having an emergency fund made up of liquid capital can allow easy access to funds that can help mitigate the effects of any of the above and lead to less financial stress. Although the amount needed as emergency liquid capital is subject to each person or family, experts agree that a good emergency fund should cover, at a minimum, three to six months’ worth of expenses. 

Investment

Aside from providing relief in emergencies, liquid capital is also important in personal finance to aid in building more capital through investments. While many investments can be calculated and contemplated for a period before committing, some, such as an IPO, require a quick answer.

When these investment opportunities arise, having liquid capital available makes it possible to commit quickly to investing before the opportunity passes. Just like visiting reputable social casinos regularly is the easiest way to earn coins, this can help generate more wealth and provide significantly more capital.

Business Importance

Liquid capital in business helps businesses manage working capital more effectively and ensures that they have enough money to operate on a day-to-day basis.

More than this, liquid capital can help a business expand and grow by providing funds for additional market research, product development, marketing, or even acquisitions. Aside from helping a business grow, it can also help companies survive a downturn in the market that would, with a lack of necessary funding, otherwise be forced to cease operations. 

Conclusion

Liquid capital plays a pivotal role in both personal and business finance as it enables financial flexibility and risk mitigation. It also allows opportunities for growth and provides stability in tumultuous markets. With financial landscapes in a constant state of change, liquid capital is likely to remain one of the most important factors of successful financial management long into the future.