Financial Explainer — current assets

As small business advisors, we understand that many owners and managers struggle to understand their small company financial statements. This blog is part of a series we've created to help. It breaks down and explains each of the components of small company accounts.

Current assets are the resources a company owns that can be readily converted into cash within a short time period (typically within a year)

Let's break these down into their components:

• Cash and cash equivalents: Cash clearly means the money held in your company's bank account. Cash equivalents, on the other hand, and as its name suggests, is almost cash but not quite. It's a stable financial asset that is highly liquid. For example, money in a deposit account with a 90-day notice period.

• Accounts receivable (or trade debtors): This is money owed to a company by its customers for goods or services that have been provided on credit. For example, you've sent an invoice and are waiting for the amount to be paid.

• Inventory (or stock): This is the value of the goods held by your company in the ordinary course of business (valued at the lower of market price or cost). For example, unsold units of a manufactured product. Or the supplies or materials used to provide a service.

• Prepayments: These are expenses that have been paid for in advance of the corresponding benefit being received. For example, prepaid insurance or office rent.

It's important to understand your current assets because you depend on them for your day-to-day operations. They also provide insight into your liquidity and ability to meet your short-term obligations.

Let's explain that in more detail:

• Liquidity: Your balance sheet is 'liquid' if you have lots of cash and near cash assets. And if you have high levels of short-term assets (what you own) relative to your short-term liabilities (what you owe), that would suggest you should easily meet your short-term financial obligations — a sign of good liquidity.

• Working capital management: Your short-term (current) assets form part of your working capital. Monitoring changes in your these assets will help you manage your working capital more efficiently and keep it to a minimum. Done correctly, this will help reduce your need to rely on external financing.

• Cash flow management: Your short-term assets have a direct impact on your cash flow. If you track how your short-term assets fluctuate over time, you'll be able to forecast cash inflows and outflows more accurately. This will also help you better understand the cash reserves you should keep available to run and grow your business.

• Inventory management: Holding stock costs money and carries the risk of obsolescence. So this needs to be managed efficiently while making sure you have enough inventory on hand to keep your business running smoothly without interruption. Assessing your inventory levels relative to your sales volumes will provide insight on this. We'll cover this in more detail in a future newsletter.

• Ageing accounts receivable analysis: Getting paid on time by your customers is critical for cash flow — the lifeblood of your business. Analysing your accounts receivable, paying special attention to amounts that are overdue, will help you manage this. We covered this in an earlier finance edition.

• Investment opportunities: Short-term investments can help you generate additional income separate to your business operations. How you do this will depend on your risk tolerance and any return you can expect.

In summary, monitoring your short-term assets and how they impact key financial metrics can help you make decisions about how best to optimise your liquidity, manage your working capital efficiently and grow your business.