Current assets are one of the most important tools in a business’s arsenal because they facilitate activities that occur every day. This blog post examines what current assets are, how they’re calculated and why they’re important.
What are current assets?
‘Current assets’ is a balance sheet term for liquid assets that can be expected to be converted into cash within one year. Or to put it another way, a current asset is any asset that is expected to be sold, consumed or otherwise exhausted during a business’s standard operations over the coming financial year.
Current assets are generally recorded on a balance sheet in order of liquidity with the assets that are more easily converted into cash placed higher up on the balance sheet.
Why are current assets important?
Current assets provide the funds a business uses to pay for daily operational expenditures and other short-term operating expenses. If a business cannot pay these expenses, it will be unable to operate and will soon go out of business. And so current assets are vital for the daily health of all businesses.
Liquidity, which is a measure of a business’s ability to meet it’s immediate and short-term financial obligations, is heavily influenced by the ratio of current assets to current liabilities. Current assets also contribute to a business’s cash flow.
Creditors and investors will often pay close attention to a business’s current assets, cash flow and liquidity when they are assessing the value of and risks associated with investing in that business.
Current assets components
Current assets can be calculated by summing the value of each of the following:
Cash and cash equivalents
These are the most liquid current assets and thus will be at the top of any current assets list. This category includes currency notes, coins, undeposited cheques, petty cash, money in business bank accounts and money market accounts.
Marketable securities are investments that will mature within a year. They’re a convenient way for businesses to store excess cash until it is required as the money invested in them is readily accessible while being exposed to minimal risk. These investments can provide greater returns than those afforded by high-interest bank savings accounts.
Accounts receivable is the term used to describe the value of a business’s unpaid invoices. Invoices with payment terms of less than a year are included in the current assets calculation.
If there is any doubt about whether a debtor will be able to settle an invoice, a ‘provision for doubtful debts’ or ‘bad debts’ account entry can be created. Such account entries give a more realistic view of the value of the accounts receivable.
The value of a business’s accounts receivable can be maximised through the use of good debt collection practices, easy invoice payment procedures and a careful assessment of the creditworthiness of potential debtors. Accounts receivable can also be converted to cash early, and practically immediately, though the use of invoice finance.
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Any business expense that is paid for in advance is included in the current assets calculation under ‘prepaid expenses’ until the item expires. As the expiry date approaches, the asset is converted into an expense. Perhaps the most common examples of prepaid expenses are insurance and prepaid rent.
Inventory or stock is generally the least liquid of the current assets. Many people think of inventory as being products awaiting sale but it also includes the raw materials required to make those products as well as any partially completed products.
The inventory values recorded on a balance sheet should take into account planned sales, any stock damage and fluctuating demand for products that may mean that a product doesn’t get sold.
Any other liquid assets
The above are the main types of liquid assets that are included the current assets calculation. Sometimes, however, a business may have other liquid assets that need to be accounted for. Examples include long-term investments with approaching dates of maturation and equipment that a business intends to sell.
If you’re unsure whether something should be included in the current assets category on your balance sheet, pop a question in the comments below.