Current Assets on the Balance Sheet

Have you ever wondered how your business stacks up financially? One crucial piece of that puzzle is the balance sheet – a snapshot of your company’s financial health at a specific point in time. Within this snapshot, you’ll find a category called “current assets,” and understanding them is essential for any self-employed individual or small business owner.

Current assets are the resources you have on hand that can be quickly turned into cash or used up within the next year to cover expenses, pay off debts, and even invest in growth. In this blog post, we’ll dive into what current assets are, why they’re important, and how you can make the most of them to strengthen your financial position.

What are Current Assets?

Current assets are short-term resources that a business owns and expects to convert to cash or use up within one year.

Current Assets on the balance sheet are usually organised based on the level of liquidity. It means that an asset that you can convert the quickest into cash.

The Balance Sheet Explained

The balance sheet is a financial statement that provides a snapshot of a company’s financial position at a specific point in time. It outlines what a company owns (assets), what it owes (liabilities), and the owner’s equity (the difference between assets and liabilities).

The balance sheet is essential because it reveals your business’s financial health, liquidity, and solvency. It helps you assess your company’s ability to meet its financial obligations, make informed decisions about investments and spending, and even secure funding from lenders or investors. In short, it’s a crucial tool for understanding where your business stands financially and planning for the future.

Why are Current Assets Important in Business?

Current assets are the financial backbone of your business, providing the resources you need to keep things running smoothly. They can be converted to cash within a year to cover daily expenses, pay bills, and even take advantage of unexpected opportunities.

Think of your current assets as a safety net. They ensure you have enough cash on hand to pay your employees, purchase inventory, and meet other short-term financial obligations. Without sufficient current assets, your business could struggle to stay afloat, especially during challenging economic times.

Beyond day-to-day operations, current assets also play a role in your long-term success. A healthy balance of current assets demonstrates financial stability and can attract investors or help you secure loans to fuel growth.

Difference Between Current Assets and Long-Term Assets

Current assets are short-term resources that a company expects to use up or convert to cash within one year. These include cash, cash equivalents, accounts receivable, inventory, prepaid expenses and other liquid assets. Long-term assets, on the other hand, are resources a company plans to hold for more than a year, such as fixed assets, property, intangible assets and long-term investments.

Examples of Current Assets

Below is a list of the main current Assets that a business might have on the balance sheet:

Cash and Cash Equivalents

Cash and cash equivalents represent the most liquid type of current asset. They include:

• Cash on hand: Physical currency, such as bills and coins, that your business keeps on hand for immediate use. It could include money in a cash register and foreign currency.
• Petty cash: A small amount of cash to cover minor expenses like office supplies or postage. While it’s a relatively small amount, it’s still considered a part of your cash assets. Read more about petty cash.
• Bank balances: Money held in current and savings accounts that can be easily accessed and used for business operations.
• Short-term investments or Marketable Securities: Highly liquid investments, such as money market funds or shares, can be quickly converted to cash with minimal risk of loss.

Cash and cash equivalents are the financial backbone of your business, ensuring you can meet immediate needs and take advantage of opportunities as they arise.

Prepayments

Prepaid expenses represent payments made in advance for goods or services that your business will use in the future. These are considered current assets because the value you’ve paid for will be consumed within the upcoming year.

Common examples of prepaid expenses include:

• Insurance premiums: Payments made upfront to cover your business insurance for a certain period.
• Rent: Payments made in advance for office space or other facilities.
• Subscriptions: Payments for software, services, or memberships that cover a specific timeframe.

Keep in mind that prepaid expenses are not immediately expensed when they are paid for. Instead, they are gradually recognised as expenses over time as the goods or services are used. For example, if you pay for a year’s insurance upfront, the cost would be spread out evenly over 12 months on your income statement.

Accounts Receivable (Debtors)

Accounts receivable represent the money owed to your business by customers who have purchased goods or services on credit. Essentially, it’s the “IOU” they give you, promising to pay within a timeframe (typically 30, 60, or 90 days).

Accounts receivable are a valuable asset because they represent future cash inflows. However, it’s important to manage them carefully, as some customers may delay payment or even default on their debts. This is why businesses track the ageing of their accounts receivable to identify overdue payments and take appropriate action.

Inventory (Stock)

Items purchased to be sold or used by the company. There are several different ways to value stock, which are discussed further in the stock section. If a company owns lots of stock, then a stocktake will be required to count the inventory to ensure the correct figure is in the accounts.

Work in Progress

Items that production has started but are not entirely ready for sale. The figure will include labour costs and any materials used. An example of work in progress is a manufacturing company that produces furniture and is partway through making a dining table. At the end of the period, only the wood was cut to size but not constructed. In the accounts, the figure will include the cost of wood and labour to cut it to size.

Marketable Securities

Marketable securities are short-term, highly liquid investments that can be easily bought or sold on public markets and quickly converted into cash.

How to Calculate Current Assets

If you are using an accounting software package, the current assets will be calculated for you when you post your transactions and viewed by running a Balance Sheet report. If you prepare the accounts manually, then you will need to calculate each of the figures and add them up.

Tips for Managing Current Assets

Effectively managing your current assets can significantly impact your business’s financial health and overall success. Here are some tips to keep in mind:

Track and Monitor

• Regularly review your balance sheet to understand your current assets.
• Track changes in your current assets over time.
• Monitor key financial ratios.

Optimise Inventory

• Avoid overstocking.
• Implement inventory management systems.
• Consider just-in-time inventory strategies.

Efficiently Collect Receivables

• Establish clear credit policies and payment terms.
• Send invoices promptly and follow up on overdue payments.

Maintain Adequate Cash Reserves

Keep enough cash on hand to cover operating expenses.

Invest Excess Cash:

Don’t let excess cash sit idle. Consider investing in short-term, low-risk options.

Current Assets Formula

An example of calculating the Current asset is Bank balance + Savings + cash equivalents + Petty Cash + Prepayments + Debtors + Stock + Other liquid assets = Current Assets

An example of current assets will look like this in the balance sheet:

Liquidity Ratios

Liquidity ratios are important as they show how liquid a business is to cover its debts.

Current Ratio

The current ratio will show how solvent a business is in the short term (one year). Banks and other financial lenders use the ratio to work out if the company has enough cash to pay off debts. The ratio is:

Current Assets divided by current liabilities = Current ratio

An example is that the current assets are 5000 and current liabilities are 2500, the ratio is therefore 2:1. If you have a current ratio of 1:1 it means that the business is insolvent.

Quick Ratio

The quick ratio, also known as the acid-test ratio, is a financial metric that measures a company’s ability to meet its short-term obligations using its most liquid assets. It’s a more conservative measure of liquidity than the current ratio because it excludes inventory, which may not be easily converted into cash.

The quick ratio is calculated by dividing a company’s quick assets by its current liabilities. Quick assets typically include cash, cash equivalents, marketable securities and accounts receivable.

A quick ratio of 1 or higher is generally considered healthy, indicating that a company has enough liquid assets to meet its short-term obligations.

Further reading is available at Accounting Coach.