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Understanding your company’s ability to meet its short and long-term financial goals requires you to keep a close pulse on the value of your current assets.
There are several different types of current assets, and understanding how they work will give you a better grasp of your financial standing. You might even gain some insights into how you can manage your current and long-term assets for greater efficiency and profitability.
What are current assets?
Current assets are items of value that a company can use or convert to cash within a single fiscal year. They can include cash, stock inventory, accounts receivable, and other resources that help a business run its immediate operations.
Current assets may also be referred to as short-term assets or liquid assets. These differ from long-term or fixed assets, which are items that can’t easily be converted into cash within a year.
A typical balance sheet will be divided into three categories: assets, liabilities, and equity. Assets are further broken down into current assets and long-term assets. Since the balance sheet is organized by liquidity, current assets are listed above long-term assets.
Examples of current assets
1. Cash and cash equivalents
Cash is the money that you currently have in your business checking account. Cash equivalents are assets that can quickly be converted into cash. These include certificates of deposit, short-term savings bonds, short-term investments, money market funds, foreign currency, and treasury bills.
2. Marketable securities
Marketable securities are liquid investments traded on public exchanges. For example, stocks, bonds, ETFs, and even cryptocurrency could be listed in this category.
However, note that you can only list marketable securities in current assets if they can be converted to cash without affecting their overall market value. For example, you cannot list company shares that have a very low trading volume, because selling them would impact their market value.
3. Accounts receivable
If a client or supplier owes you outstanding debts, this is classified as accounts receivable. This category includes all the monetary value due to a company for goods or services that have been delivered or used by a customer who has not yet paid.
As long as payments are expected to be made within a year, they can be listed in accounts receivable. But not all receivables can be included in this column. For example, credit accounts that have payment periods greater than a year would be excluded from current assets. Likewise, accounts that are doubtful or cannot be collected should be listed in a separate section and subtracted from Accounts Receivable.
Inventory is all the products sold by a company, including raw materials, supplies, works-in-progress, and finished products. However, this category can be trickier to calculate because it allows for some level of estimation and prediction of future sales.
For example, industrial machinery may not be as liquid as a trendy sneaker, but the market can be unpredictable. A new trade agreement could open up a large volume of sales for the machinery, while shifts in cultural attention could result in a pileup of sneaker inventories.
When reviewing inventory listed in current assets, you should examine the numbers carefully and remain skeptical of unusually high or low numbers in the context of the industry.
Supplies are listed under current assets, only when they are unused. In this state, they still represent an economic asset that could potentially be sold for cash. However, this changes the moment they are used in operations or production. The supplies then become expenses, which are listed in a different section on the balance sheet.
6. Prepaid expenses or liabilities
Prepaid expenses are listed as current assets, not expenses like their name suggests. Even though they cannot be readily converted into cash, insurance payments or prepayments for a lease may count as current assets.
7. Other liquid assets
If you have other current assets that can be easily sold or converted to cash, you can list them as "other short-term investments." This is a broad category but can include things like tax refunds or short-term security investments that can be quickly sold for cash.
What can current assets tell you about a company’s liquidity?
Understanding the value of a company’s current and fixed assets can give you insights into its liquidity and operational efficiency. Of course, these numbers only form part of the whole picture, and the ratio of current to fixed assets may vary according to industry and company size.
For example, a company that sells Software as a Service (SaaS) is likely to have higher amounts of current assets compared to fixed assets. Since they develop a digital product, they can conduct instant sales online without stocking physical inventory. As a result, they have high liquidity in the form of cash that can be used to cover their expenses and other liabilities.
On the other hand, a real estate company may have low liquidity due to the fact that they have high-value fixed assets that aren't easily converted to cash.
Some investors may only invest in companies with high current asset ratios, as these companies have greater cash reserves to pay staff, purchase inventory, and maintain operational efficiency. Having sufficient current assets lowers the risk that the business will need to cut back or even shut down in periods of financial uncertainty.
How to calculate current assets?
If you're reviewing a company's completed balance sheet, you can usually find the value of current assets listed under Total Current Assets. But if you want to run the calculation yourself, simply add up the different types of current assets.
Here's the current assets formula:
Current Assets = Cash + Cash Equivalents + Marketable Securities + Accounts Receivable + Inventory + Supplies + Prepaid Expenses + Other Liquid Assets
Besides knowing the total value of your current assets, there are other ways to use current assets to understand various financial aspects of a business.
Here are some other useful formulas:
- Current Ratio: the ratio of current assets to current liabilities, which can tell how much money business is expecting to receive within the next twelve months.
- Formula for Current Ratio: Current Ratio = Current Assets / Current Liabilities
- Quick Ratio: a ratio showing how a company can pay short-term debts by only considering assets converted to cash within 90 days.
- Formula for Quick Ratio: Quick Ratio = (Cash + Cash Equivalents + Marketable Securities + Accounts Receivable) / (Short-term Debt + Accounts Payable + Accrued Liabilities and Other Debts)
- Net Working Capital: roughly how much money a company has to operate presently.
- Formula for Net Working Capital: Net Working Capital = Current Assets - Current Liabilities
Automate your bookkeeping with Ramp
If you’ve been wondering how to quantify your business's current value in terms of its current resources, then hopefully this explanation of current assets has helped you understand how to better measure liquidity and operational efficiency. Knowing the value of your current assets is key to making informed decisions on how to meet short-term obligations and plan for future liabilities.
To help you make those decisions, Ramp has advanced software that can automate tedious bookkeeping tasks. That way, you can spend more time on operations. We also offer a range of services from expense management to AI-powered insights for optimizing your business’s financial operations.