A current asset of a business is any asset that can be sold or used in operating the business within a given financial year. It is an asset that appears in the balance sheet of the business and can be converted to cash over the next year. It contrasts with long-term assets, like land and similar illiquid investments, which may be difficult or impossible to encash in one year.
As a Small Business Owner trying to understand the items on the current assets section of your balance sheet, it can be difficult to tell the difference between what to count as a current asset and what constitutes a longer-term asset. However, the general rule is that anything that can be easily turned to cash within one year or less will pass as current asset. Here are different types of current assets and what they represent:
- Cash and Equivalents: These include cash in the bank account of the business, cheques in the name of the business that are yet to be deposited, and petty cash from sales by the business.
- Accounts Receivable: These are payments for goods or services delivered to customers by the business, but are yet to be paid for by the purchasers. These are credit transactions for which the business has issued invoices to customers who have payment periods of 30, 60, 90 or 120 days, as the case may be. Accounts receivable are classified as current assets because they will be paid for in cash, via a bank transfer, or with instruments that can be converted to cash, like cheques.
- Inventory: These are goods that the business has in storage for replenishing its stock, while waiting to be sold. Inventory constitutes current assets because the business expects to sell or otherwise liquidate them within one year, particularly if they are perishable, like food and similar consumables. For manufacturers, inventory may include supplies, like raw materials or similar items, needed to make products or keep the business running.
- Marketable Securities: These are convertible financial instruments, such as stocks, bonds, treasury bills and fixed deposits, held by the business and can be sold for cash. These securities are considered marketable if they can be exchanged at face or near-face value within the year they were purchased by the business.
- Prepayments: These are future expenses that the business has paid for. They are costs that have been paid for but are yet to be used. An example of a prepaid expense is insurance, for which the premium is usually paid in advance for many months, say one year. Another example is rental payment that covers 12 or more months, but paid for ahead of time. Same goes for subscription services, like when the business pays for a 12-month subscription on its satellite television service. For these prepaid expenses, the business initially records the expenditures as prepaid expenses, or assets, and then charges them as expenses over the period of usage.
What does the current account position of the business tell the Small Business Owner? Simple. It is a key indicator of the short-term financial health of the business. It signals the capacity of the business to pay its bills as they fall due, and how variations in revenue may affect its operations. More importantly, it enables you, the Small Business Owner, to compare your current assets with your current liabilities, so that you can aim for the right balance of current assets to liabilities.
In essence, if the current assets of your business exceed its short-term liabilities, the assets will cover short-term debts. But a business with too many current assets might also not be investing enough of its profits in income-producing projects. That said, given that you always want the current assets of your business to outperform its current liabilities, how do you boost its current assets? Here are four steps to improve your current assets balance:
- Cash Is King: Fast-track accounts receivable, which is a key component of your current assets. Strengthen current assets by promptly collecting on invoices. A pile of overdue invoices can seriously damage the cash flow of the business, and worsen its current assets position. The business should send an invoice immediately it sells an item or provides a service. Aim to collect receivables in a timely manner, no longer than 60 days. The longer the wait to collect on an invoice, the lower the chance of collecting on it. Use invoicing and accounting software to automate collections. Follow up with written reminders, phone calls and personal visits, and collect on your invoice, on time, most times.
- Liquidate Idle Assets: Does your business have assets, like machinery, equipment, inventory, etc., that are lying around, and not in use? If it has, sell them. Liquidating idle assets will increase the current assets of your business.
- Invest With Care: Always monitor the cash flow of your business, with an eye to leveraging any investable cash. In investing, strive to balance risks and returns, by building a portfolio of assorted instruments, like stocks, bonds, treasury bills, etc., with varying maturities, from 90 days to 12 months, or longer. Carefully chosen investments can bring cash to the business and improve its current assets.
- Borrow With Caution: Never borrow without a plan or purpose. Only borrow when you need to. When you do, consider how your cash flow will meet the monthly payments. Analyse the cost and benefit of the loan, and determine how it will help to grow the business.
If your business is able to achieve a positive balance of current assets to liabilities, it will be in a position to secure financing that will help it to realise its daily, monthly and yearly trading goals.