Calculating Current Assets: What You Need to Know
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Understanding what your business is worth in some ways begins with understanding how to calculate current assets. So what exactly constitutes current assets and then, of course, how do you go about calculating those? In this article, we cover what you need to know regarding your company's current assets and why you should be prepared to go ahead and calculate those assets. They are important when it comes to painting the bigger picture of your company's financial health.
Understanding What a Current Asset Is
Basically, if you were to sell your business right now, your current assets would be the cash or anything that you could essentially convert to cash within a year's time. These liquid assets can be sold or consumed for the equivalent cash value. If your company's operating cycle is longer than 12 months, then you would base the current assets on the length of your particular operating cycle per the balance sheet.
Current assets really do paint a picture of the overall financial health and well being of the business. If for instance, you apply for a loan you might be able to use some of those assets for collateral. Your assets are what enable you to survive the down times and the unexpected "emergencies" that can arise in the course of business. Having enough current assets on hand is thus integral to keep your company moving forward.
If the state of your current assets isn't exactly healthy then you could experience setbacks down the road. You need to strengthen that asset position, thereby enabling you to more effectively handle whatever comes your way.
A Few Examples of Current Assets
As noted, an asset is cash or that which could theoretically be converted to cash in a year, and it is also defined as that which is strictly owned by the business. Some examples of current assets are:
- Accounts receivable
- Certain investments
- Office supplies
- Prepaid expenses such as rent
- Raw material
- Finished product
- Liquid assets
Again, to understand whether or not it is a current asset, you need to figure out how long it would take to liquidate the asset in question—this must generally fall within a year.
Calculating Your Current Assets
In order to calculate all current assets of the business, you first need to ask: does the business own it? Does it have value? And can it be converted to cash or consumed within 12 months? If it falls within this category, then it should definitely be part of your total current assets. Start by creating a list of everything you can think of. Once you have this list organized then you need to start adding things up.
Below is a simple example of how your current asset balance sheet might look.
- Cash $65,000
- Securities $40,000
- Investments $10,000
- Accounts Receivable $25,000
- Prepaid Expenses $10,000
- Inventory, materials, and Finished Goods $52,000
- Office Supplies $22,000
- Liquid Assets $12,000
= $236,000 in Total Current Assets
What to Do with Current Asset Information
Upon calculating the data regarding your current assets, you can then use it to understand more about the financial state of your business. For instance, networking capital is the current asset minus current liabilities. Such liabilities are those which need to be paid within 12 months. So things such as short term debt and accounts payable for example are considered current liabilities. Your net working capital is a good indicator of your liquidity.
Your Current Ratio is figured by dividing current assets by current liabilities. Again, this goes toward understanding more about how liquid the business is. If your current ratio is less than 1.0 this could indicate a financial problem within the company. A ratio of 1.2-2.0 is ideal suggesting that on a monthly basis your company is stable and not likely to fall behind. Too high a current ratio though could mean that it's time to start reinvesting revenue.
Then you have the Average Current Assets formula. This represents the mean value of current assets over a period of two years or longer. The calculation looks like this:
(Total current assets for a prior 12-month period/) + Total current assets for most recent 12 month period/) / 2
This number can be used to help the budget and essentially plan for the future of the business.
Strengthening the Position of Your Current Assets
Getting the numbers together is the start—what do you do with them from there? By understanding where your current ration stands or where your networking capital happens to be you can revisit your monthly budget and see where you need to improve. As you start working toward strengthening that asset position, you should see results in the form of more assets.
Below are a few of the steps that you can take to help the company improve its position:
Collect outstanding invoices. Leaving unpaid invoices on the table for over sixty days, for example, is hurting the company. Let customers know your policy right off the bat—they will be more apt to respect it and subsequently pay on time.
Borrow responsibly. Taking out business loans is certainly fine, however, make sure you're not overextending yourself. Do not borrow more than what you actually need.
Liquidate that which you no longer use. Is inventory just sitting there? This is basically wasting money that could be used for other things.
Make smart investments choices.
The bottom line is you want a firm handle on where you stand financially speaking. The more you know about what your business is worth, the better prepared you are to make smart decisions not just about the "now" but about the company's future as well. Those businesses that thrive, that manage to grow and prosper are the ones that gather all of the information, those that work the numbers and understand the formulas. So where does your company stand?