Net worth is the total count of assets and cash an individual owns less the total liabilities. In simple terms, it is the value by which the assets exceed the liabilities. Net worth can have a negative value, though, given that the total liabilities exceed the value of total assets.
While you can transform many assets into liquid assets, there are some which you can’t. Estates, equipment, or machinery can not be liquidated easily within a shorter time frame.
The need to access money quickly and determine the business’s financial status has brought about the need to define this concept. So, what is it? And what does it matter?
What Does Liquid Net Worth Mean? – Insight on Definition and Importance
Liquid net worth refers to the business’s total liquid assets, fewer liabilities, and financial obligations. It can also refer to the value of the business’ assets if it was all liquidated. Let’s dig deeper and understand its components.
Liquid assets are the assets that can have a quick transformation into cash within a short time. They can be referred to as cash or cash equivalents. Assets making up the liquid assets include stocks, bonds, savings account, funds, and all the assets sold quickly.
On the other hand, liabilities entail all the business debts and all financial obligations of the business. They include wages payable, expenses, loans, bonds, and mortgages.
To determine the liquid net worth, you subtract the total liabilities from the total liquid assets. The liquid worth net is used to measure the business’s financial status and provides flexibility when money is needed on short notice.
It is easy to confuse net worth and liquid net worth because they resemble each other in many aspects. So how do they differ?
Liquid Net Worth and Net Worth – How Do They Differ?
While it is easy to confuse them, they are not the same. The net worth is the total assets of a business, inclusive of liquid and non-liquid assets. In comparison, liquid net worth entails only liquid assets which can be sold quickly to get cash.
What Is the Assets’ Classification?
There are two categories of assets. They include liquid assets and non-liquid assets. The latter refers to those with quick transformation capabilities into cash. They include:
- Stocks (see also stockholders)
- Cash in hand, bank, and cash equivalents
- Marketable securities
- Money market accounts
- Accrued income
- Promissory notes
- Bonds
On the other hand, non-liquid assets are those assets that can not be transformed into cash quickly. They include:
- Buildings
- Land
- Real property assets
- Machinery
- Equipment
How Is Liquid Net Worth Important?
Your net worth gives you an optimized figure of the value of your assets. This is because, when determining your net worth, you only take the total assets and subtract from the total liabilities you have.
On the other hand, Liquid net worth gives an accurate representation of your assets’ worth available at the moment. Especially if you wanted to liquidate your assets within the shortest time possible, your liquid net worth could sometimes be a representation of your actual net worth. This is because, when determining the liquid net worth, the liquidation cost is put into consideration. It will not be applicable only if your assets are in a more liquid form.
The liquidation cost is the significant difference between the two.
How to Calculate Liquid Net Worth
Calculating liquid net worth requires no complex concept. You take the total assets you have, and you subtract total liabilities. That is:
Liquid Net Worth = Liquid Assets – Liabilities
You can also decide to include the liquidation cost in your calculation, such that the resultant value becomes your net worth. When subtracting the liquidation cost from the liquid net worth, the resulting figure is your net worth. That is to say:
Liquid Net Worth – liquidation cost = Net Worth
Otherwise,
(Assets – Liabilities) – Assets Liquidation cost = Net Worth
How to Optimize Your Liquid Net Worth
It is healthy for any business to have a positive net worth rather than a negative net worth. Therefore, it is worth it to optimize your liquid net worth. Below are the tips you can use to increase your liquid net worth.
Reduce your Expenses
You’re likely to spend more than you need to. Therefore, you need to analyze your expenses and identify ones you can reduce or do away with. These expenses may include day-to-day expenses (see also day trading), as well as major long-term expenses.
You can either reduce or cut off some expenses. Cutting off the expenses increases your liquid net worth drastically. Still, if you can’t do away with the expense, you can reduce it. The small reductions here and there will see your liquid net worth improve gradually.
However, you don’t need to be pressured too much. Don’t move from spending $20,000 to $10,000. A sudden drastic change can affect your business negatively. Have a strategy and reduce the expenses gradually.
Diversify Your Income by Starting a Side Hustle
There are two approaches to increasing your liquid net worth. You can reduce the expenses, or you can increase the income. Having several sources of income is beneficial in that your income flow increases. You also get to diversify your income sources so that if your primary income source fails, you have the side hustles to save the situation.
You can consider doing online hustles like freelancing, blog writing, or transcription. You can set aside some time for the side hustle. These endeavours will see you earn an extra cent on top of your primary income.
Side hustles are best if you major in your experience. Doing something you’re experienced at is easy and can yield more output than doing something you have little knowledge about. You shouldn’t limit yourself, though; you can learn new ideas and skills to help you in your side hustles.
The only downside to venturing into a side hustle with no existing experience is that it may take you time before you gain the relevant skills. This may waste more time and have poor yields.
Have a Look at Your Annual Costs
You may be incurring more on quarterly or annual costs without your knowledge. These costs drag your liquid net worth down. Many people ignore this aspect in their financial transactions. Bills and expenses paid quarterly or annually like vacations, insurance covers, and other long-term bills reduce the liquid net worth.
You’re, therefore, supposed to review them and cut on areas that can be reduced. If their effects are adverse, you may consider cutting off for good. Don’t be overwhelmed, though; have this in an established order, where you make one change at a time.
Start Investing
Investing and trading is the right approach to increasing your liquid net worth. There are several investment opportunities you can major in. You can choose to invest in the stock market, real estate, securities, or Exchange-traded funds. Weigh in your financial muscles and decide on an investment to venture into.
Moreover, you can use investment apps, robo advisors, or online brokerages for your investment venture. Such apps are easy to use and simplify business requirements, which may hinder some people from analyzing stock market reports and investing in the stock market. Besides, such apps have low capital requirements for starters; therefore, you can start investing with the little funds you have.
Find a Way to Cut Down on Your Liabilities
The first step to optimizing your liquid net worth is to reduce your credit card debt and liabilities. You’re supposed to pay off all or most of your debts to reduce the money you owe. Increase the rate of paying your debts by opting to pay them weekly rather than monthly basis. The increased rate of debt payment reduces the principal you owe quickly, therefore, reducing the interest payable. This will see your liquid net worth going up gradually.
Other than paying off your debts, you can also optimize your liquid net worth by eliminating some liabilities, if any. For instance, you can reduce the outstanding credit card balances.
What Factors Affect Liquid Net Worth?
Factors that affect this aspect vary depending on the types of assets you have. Liquid assets will have a higher liquid net worth, for they have little to no liquidation cost. However, non-liquid assets will have a lower liquid net worth. Several factors affect non-liquid assets.
Liquid Assets
These include cash and equivalents. They may further compose of cash on hand and bank, savings account, and certificate of deposits. When liquidated, these assets incur no liquidation fees and would directly translate to the total liquid net worth.
However, with the certificate of deposits, you’ll pay a prepayment penalty if the liquidation happens prior to the completion of the stated term.
Retirement Plans
The retirement funds in your retirement accounts do not transform to liquid net worth as a whole. There are imposed charges that lower the final liquid net worth. For instance, if you have a 401(k) plan savings, you’ll incur income taxes. In addition to the retirement tax, you’ll again need to pay a 10% fee for early withdrawal if you’re under 59 ½ years of age.
Other charges include liquidation fees paid to the plan administrator and commissions on the assets’ sale.
You’ll incur fewer charges only if you have your funds in a Roth IRA, and that you’re 59 ½ or above, and that you have five years in your savings plans. Those that qualify for these conditions are not taxed. Therefore the whole of their savings accounts value will transform into the liquid net worth.
However, individuals under 59 ½ years will pay ordinary income tax besides paying the 10% early withdrawal penalty.
Real Estate
Real estate is one of the most complicated industries when it comes to liquidation. It takes way too long to sell a real estate asset.
Liquidating a real estate asset incurs several costs that lower the liquid net worth. You’ll have to pay the agent commission, attorney fees, and other taxes upon transaction.
The Bottom Line
Liquid net worth is an excellent way of determining your actual financial standings. You also get to learn your assets’ worth if you need cash on short notice. Several factors affect the liquid net worth, and it’s upon you to learn the tips that would help increase your net worth.
