A business should always be keeping tabs on what it owns and what it owes. As a rule of thumb, a healthy business owns more than what it owes.
But what you own has different levels of use when it comes to paying down debts. The money you hold in your bank account is more ready to use than something like the real estate you own.
To better track what’s on hand to pay debts, businesses track current assets. Read on to learn about this way of understanding what you own, why it’s relevant to your financial health, and how you can manage it to optimize your business.
Current assets definition
Current assets are assets the business owns and expect to be converted into cash or used up within one year or one operating cycle of the business.
Every business has what it owns and what it owes—assets and liabilities. But some assets and liabilities carry longer value than others. For example, a vehicle will be used for years while cash in the bank account could be used within a month.
To understand a business’s short-term financial health, finance pros look at current assets. These are the assets that will have their impact in the business within a year or within one operating cycle.
Current assets vs liquid assets
Assets also have different degrees of ability to be turned into cash on short notice—this is called liquidity. An asset that can be easily turned into cash quickly is called a liquid asset.
The main difference between current assets and liquid assets is the timeframe. A liquid asset must be able to be converted into cash immediately while current assets have a timeframe of one year.
Something like inventory or accounts receivable would not be considered a liquid asset because of the difficulty to turn them into cash immediately. Comparatively, marketable securities would be considered a liquid asset because they can be easily sold.
Generally speaking, all liquid assets are current assets but not all current assets are liquid assets.
Why current assets matter
Current assets are a significant measure of a business’s financial health. They represent the assets that will become cash in a reasonable timeframe to pay down debts, fund daily operations, and reinvest in the business.
It’s a common metric used by both investors and lenders to determine how primed a business’s creditworthiness or potential for growth.
Current assets are also used in the calculation of multiple liquidity ratios including the current ratio. The current ratio formula is:
The current ratio is used to understand how prepared a business is to pay down its debt. If the current ratio is greater than one, they own more than they owe. The business could liquidate all of its assets, pay down its debts, and have money left over.
Understanding your current assets is an essential part of understanding your short-term financial health. It’s how you understand your ability to cover costs and invest in the business in the immediate future.
Examples of current assets
Take a look at your balance sheet and you’ll find multiple examples of current assets. Some of the most common include:
- Bank accounts: The cash held in any checking accounts or saving accounts
- Digital wallets: Platforms like PayPal that hold a cash balance that is easily accessible
- Accounts receivable: Any outstanding invoices that are expected to be paid within a year (do not include any bad debts that are not expected to be collected)
- Prepaid subscriptions: Annual subscriptions that are paid upfront to something to be provided over a 12 month period
- Prepaid insurance: Payments for insurance coverage that will be provided within the year
- Accrued dividends: Returns on investments that will be paid out within the year
This is by no means an exhaustive list—the current assets that a business holds will vary depending on the size of the business, the industry, and what they choose to put their money into.
To help illustrate the full range of current assets, lets break them down into broad categories or types.
Types of current assets
Every business will have its own collection of current assets. However, there are some common types shared by businesses of all sizes and industries.
Cash and cash equivalents
Cash and cash equivalents is the money you hold across all accounts. This includes the cash physically held by the business, money in a bank account, or funds held in a digital wallet.
Cash equivalents include low risk, highly liquid investments that can be easily turned into cash. The most common examples include government treasury bills (T-bills) and bank certificates of deposit.
Accounts receivable
Almost all accounts receivable are considered current assets. It ultimately depends on what your payment terms are.
If all outstanding payments have payment terms of less than a year, they’re considered current assets. However, this can get complicated for businesses that work long-term projects and have payments in intervals.
Say a business invoices the full amount of a project that is to be completed over five years. Every year, 1/5th of the invoice is paid down. In this instance, only the payment to be made in the current year would be included in current assets as all other payments are beyond the scope.
When calculating current assets, be mindful of when the bill is expected to be paid. Long-term accounts receivables should not be included.
Inventory and stock
Inventory and stock include both the raw materials used in production or already produced goods that are being held for sale.
Inventory will nearly always be a current asset. Goods are expected to sell within a year and, if push came to shove, the raw materials and components could be liquidated on short notice.
However, inventory may be considered a long-term asset if a business has a long-term sales process. A business selling socks can confidently say its inventory is a current asset, but what about a business selling large-scale machinery?
Before defining inventory and stock as a current asset, think about how long it takes to turn one piece of inventory into a sale. If it takes your business more than a year to liquidate inventory, it should be left out of your current assets.
Prepaid expenses
Prepaid expenses is a term that refers to any goods or services that have been paid for but not rendered.
The most common example of prepaid expenses are annual payments for something like software or insurance. In both cases, you’ve paid for something that is owed to you over the following months.
While these services aren’t converted into cash, they are still redeemed within the year and are included in the current assets calculation.
Short-term investments
An investment must meet one of two conditions to be considered a short-term investment:
- It has a maturity date (i.e. will be converted to cash) within one year
- It is highly liquid (i.e. it can be turned into cash very easily)
Some common examples of short-term investments are certificates of deposit, money market accounts, and government bonds.
To make tracking current assets easier, it’s best practice to separate your long and short-term investments on the balance sheet.
Current assets vs. non-current assets
If current assets include items that are redeemed within one year or business cycle, are non-current assets items redeemed outside of a year or business cycle?
Essentially, yes. Non-current assets (or long-term assets) include anything that a business plans to use or hold onto in the long-run.
Some common examples are machinery or property which are held onto and used in operations for a long-period of time. They are also difficult to turn into cash on a short-term notice.
It’s helpful to think about current and non-current assets from the perspective of what you would turn to if you needed cash right now. It’s easy to reach out to customers for outstanding accounts receivable or sell off a short-term investment. It’s not as easy to sell a piece of property.
How to calculate current assets
To calculate your current assets, you’ll need an updated set of bookkeeping and, ideally, an updated balance sheet. All information should be in the top section of the balance sheet, the assets.
Now let’s look at the different methods of calculating current assets.
Current assets formula
The basic formula for calculating current assets is:
Each component of the formula is a category of current asset type and may include multiple lines from your balance sheet. As an example, cash and cash equivalents should include all cash on hand and held in bank accounts or digital wallets.
Otherwise, simply add up the lines that correspond with each item. By summing up each category, you get your total current assets amount.
Including short-term investments
By including short-term investments, the calculation gets a little bit trickier.
If you’re already tracking short-term and long-term investments separately, then adding short-term investments is easy. All you need to do is add the amount to the current assets formula above.
However, if you have both short-term and long-term investments in the same line on the balance sheet, you’ll need to do some digging.
As a reminder, short-term investments only covers easily liquidated investments that are expected to mature within the year. The examples a business is most likely to hold are government T-bills and bank certificates of deposit.
Excluding non-liquid assets
In the current assets formula are multiple categories of what are considered “liquid” assets. Liquid assets refers to anything that can be easily converted to cash.
In some cases, what’s a liquid asset to one business isn’t to another.
Look at inventory as an example. For businesses stocking high priced, limited assets, they may have a sales cycle longer than a year.
It’s similar for accounts receivable. If any outstanding amounts have a timeframe for payments longer than a year, they should not be included.
Take a critical look at each category for any exceptions that should be excluded. What may be generally categorized as a liquid asset may not be a liquid asset for you.
Managing current assets for maximizing growth
Now that we’ve established what current assets are, let’s dig into how businesses manage them effectively in their day-to-day operations.
Effective cash flow management
Cash and cash equivalents are a large part of a business’s current assets. Sustaining a high amount of current assets starts with effective cash management.
Cash flow is how cash enters and exits the business. Timing payments so they come in before they go out helps you maintain a healthy cash level, and in turn, a healthy current assets level.
Consider setting up a rainy day fund that you maintain a regular balance of. Not only does this help protect you from cash flow disruptions, but it helps you maintain a steady amount of current assets.
Follow our 12 tips for better cash flow management to take steps towards maintaining a healthy cash balance.
Optimizing accounts receivable
Your accounts receivable amount is included in the current assets calculation, but you should still be mindful amount turning those outstanding amounts into cash on hand.
Make use of accounts receivable automation to streamline the collections process. This helps you pursue payments without having to draft emails, make phone calls, or have unnecessary follow ups.
Remember that accounts receivable is considered a liquid asset. It may seem like it can only be turned into cash when a customer is ready to pay, but there are other options.
If you’re looking to turn accounts receivable into cash fast, look into accounts receivable financing. While the costs will cut into how much cash you receive, it can be a useful tool when used effectively.
Efficient inventory management
Inventory management is closely tied to cash flow management: if you’re making bulk purchases for a large amount of cash, you need to be mindful of how you’re using inventory to generate cash.
If you’re not already, start tracking the average age of inventory. This calculation shows you the average amount of days it takes for inventory to sell. The calculation is:
To find your average inventory balance, simply add the inventory balance at the start of the year to the inventory balance at the end of the year and divide by two.
If it’s taking you a long time to turn inventory to cash, you need to consider either having less inventory on hand or look at ways to move through inventory faster. A common approach is to run sales for old inventory that’s been taking up space.
As a reminder, if the average age of inventory is greater than a year, it wouldn’t be included in the current assets calculation. Look for ways to speed up turnaround times and it can be included again.
Streamline current assets with BILL
Managing and optimizing your current assets doesn’t need to be a hassle. With some updates to your tech stack, you can automate much of the work associated with current assets.
Take accounts receivable for example. With BILL, you streamline the accounts receivable process with simplified invoice creation, tracking, and follow-up. Know exactly where your outstanding invoices are in the process and set up automated reminders to easily nudge customers.
