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Current Assets = Cash + Cash Equivalents + Inventory + Accounts Receivables + Marketable Securities + Prepaid Expenses + Other Liquid Assets
The current assets formula is the sum of cash on hand and other assets that are convertible to cash within one year. All of these assets typically appear on a business’s balance sheet.
If a couple of your customers suddenly backed out of a contract or decided not to buy your product or service, would you still be able to pay all your bills? Would you have other, alternative sources of income to fill the gap? If your company has sufficient current assets, then the answers to both questions would be yes. But if your asset position isn’t as strong, even small variations in revenue can disrupt your business.
The current assets formula, sometimes called the total current assets formula, is a key indicator in business finance of your business’s short-term financial health. If your current assets exceed short-term liabilities, you have enough assets to pay off short-term debts. At the same time, having too many current assets can be a bad thing. This might mean that you’re not investing profits into lucrative projects.
Achieving the right balance of current assets to liabilities signals to lenders and investors that you have enough cash on hand for emergencies and that you’re investing money in the right opportunities. Learn the formula for total current assets, see an example of how the formula works, and learn how to utilize current assets to gain further insights into your business’s financial health.
The current assets formula is:
To help you better understand this, below is an example of the current assets formula based on the year-end balance sheet for a sample business, ABC Business. If you’re unsure how to create a balance sheet, refer to our free balance sheet template.
For now, focus on the parts of the balance sheet which show total current assets and total current liabilities for ABC Business.
Plugging in each type of asset from the balance sheet into the current assets formula, here’s how you’d calculate current assets:
Current Assets = $100,000 + $10,000 + $50,000 + $35,000 + $5,000 = $200,000
Current assets include cash and other liquid assets that can be converted to cash within one year. Beneath current assets, you will find current liabilities, which are debts that you have to pay back within one year. Current liabilities for ABC Business total $120,000.
The best way to evaluate current assets is by comparing the number to current liabilities. In the example above of the total current assets formula, ABC Business has significantly more current assets than current liabilities, which is a positive sign. This means ABC Business has good short-term liquidity and can afford to pay short-term debts back using current assets. Given this tells us so much about ABC Business, you can understand why the current asset formula is so important to your business.
Sometimes, businesses have a hard time deciphering what each line means on the current assets portion of the balance sheet. When doing your business accounting, knowing what to count as a current asset in the current assets formula and what constitutes a longer-term asset can be difficult.
Your accountant or bookkeeper can help here. But when looking at this yourself, know that, in general, anything that’s easy to turn into cash within one year or less goes into the current assets category. These include cash, cash equivalents, inventory, accounts receivable, marketable securities, and prepaid expenses.
Here are the different types of current assets and what they each mean:
Cash and cash equivalents include cash in your business bank account, checks that you’ve received and haven’t deposited yet, and petty cash.
Accounts receivables are pending payments that customers owe you for goods or services that they’ve already purchased. For many companies, especially B2B businesses, customers don’t provide immediate payment. Instead, the business sends the customer an invoice, and, in most cases, the customer gets 30, 60, or 90 days to send in their payment. Accounts receivables are considered current assets because the payment comes in as cash (e.g. a wire transfer) or can be easily converted to cash (e.g. a check).
Inventory refers to unsold goods that your company keeps on hand to replenish stock. Inventory is a current asset because within one year, the business will either sell the inventory to customers or can liquidate the inventory. All businesses, but particularly those that sell perishable inventory—like food items or cosmetics—should be careful not to overstock.
Sometimes, in addition to inventory, there’s a separate line item on the balance sheet for supplies. This line is for raw materials or other items that you need to make your product or run your business.
Marketable securities are financial instruments that can be easily converted to cash, such as certain stocks, government bonds, treasury bills, and certificates of deposit. To be considered a marketable security, you must able to cash in the security on a stock exchange or bond exchange and get the face value (or close to face value) within a year of purchase.
Prepaid expenses is a catch-all term for expenses that you’ve paid already, but you haven’t yet used or received the underlying asset. For example, many companies purchase general liability insurance, and the insurer might require or give the business the option to prepay one year’s worth of premium costs. You should categorize these costs as prepaid expenses on the current assets section of your balance sheet.
For example, let’s say you prepaid a $2,400 annual insurance premium at the beginning of the year. To begin, you would note that amount in prepaid expenses on your balance sheet. But each month, you would deduct 1/12th of that cost—$200 in this example—from prepaid expenses and note it as expenses on your income statement.
Ideally, when doing your accounting, you should create an updated balance sheet every month so that you understand your business’s asset position and how it’s changing over time. If you have a business loan from a bank or an SBA loan, then the lender might require you to submit updated monthly balance sheets.
To get the most out of the formula for total current assets, you shouldn’t look at your results in a vacuum. You should use the number to calculate other ratios that give insight into your business’s financial health. For example, like we learned above, what is most important is that you compare your current assets to your current liabilities. There are a number of formulas that allow you to do so.
Here are other formulas based on the total current assets formula you need to know.
The current ratio tells you the percentage of your firm’s debts that you can pay off with liquid assets. Instead of seeing current assets in a vacuum, you can see how the level of current assets compares to the level of current liabilities. In the example above, the current ratio is $200,000 divided by $120,000, which equals 1.67. Calculating the current ratio also allows for easy comparison over time.
The quick ratio is similar to the current ratio, but only considers the most liquid assets, so you would need to exclude inventory and prepaid expenses. Similar to quick ratio, this ratio will tell you the percentage of your firm’s debts that you can pay off with the most liquid assets. In the example above, the quick ratio is $185,000 divided by $120,000, which equals 1.54.
The net working capital formula tells you whether you have enough assets on hand to pay off all bills and debts due within one year. If you have a positive amount of net working capital, that means you have excess cash that you can use towards day-to-day expenses. In the example above, the net working capital is $200,000 – $120,000, which equals $80,000.
Compared to the current assets formula, the formula for average current assets gives business owners an idea of the average assets they have on hand during a typical one-year period. This can help entrepreneurs plan for the coming year and assess whether they have sufficient assets to reach sales goals.
The right amount of current assets will vary significantly based on your industry and your business’s goals. But, says Chris Balestrino, a partner at Madison One Capital, “You always want to have more in current assets than you have in current liabilities. Businesses, at a minimum, should have a one to one ratio. This shows your business is solvent and can operate monthly without falling behind.” And ideally, you should strive for a current ratio of 1.2 to 2.0.
A ratio less than one means you don’t have enough assets to cover your liabilities, which signals low liquidity. Although you definitely want to have more assets than liabilities, there can be a point where you have too many assets. A ratio greater than two means you might not be investing cash in revenue-generating opportunities. In that case, you want to think carefully about your business’s short-term goals and how smart spending can help you achieve them.
The total current assets formula tells you a lot about your business’s financial health, but there’s another important use for current assets as well: You can pledge current assets as collateral for a loan. That makes current assets very valuable, especially as a route to bank financing and other collateral-based loans. In this case, the more current assets you have, the more likely you will be to qualify for a loan and could also increase the loan amount you’re eligible for.
James Stefurak, Founder of Monarch Financial Research, says, “Current assets may be pledged as collateral for loans, resulting in a lower interest rate than an unsecured loan. Therefore, when seeking business financing, it’s important to maximize your current assets. This means including all current assets such as raw materials, work-in-process, and finished goods/inventory.”
Once you plug your numbers into the total current assets formula and do related calculations, you might find that your current ratio is either negative or not quite where you want it to be. Don’t worry—this is a dynamic number that can change frequently, so you should track it month over month.
These are some steps you can take to improve your asset balance.
Accounts receivables is an important portion of your current assets. To shore up current assets, you should promptly collect on invoices. If you fail to do so, you could end up with a big roster of overdue customers, making it hard organizationally and from a manpower perspective to get what’s owed to you.
“Cash is king,” says Madison One’s Balestrino. “Collecting on receivables in a timely manner, within 60 days, can properly position a business to meet its short-term obligations.” And research indicates that the longer you wait to collect on invoices, the more likely the invoice is to go uncollected. The best practice is to send the invoice right after you sell the item or provide the service. Oftentimes, invoice collection software and business accounting software lets you set up automatic invoice reminders so that you’re on top of collection all the time. Implementing the reminders alone could have a huge impact on your total current assets.
Reducing your short-term and long-term debt can also improve your current ratio by reducing your current liabilities. The key is only to borrow how much you need and nothing more. Before you borrow, you should consider the size of the monthly payment and whether your cash flow can handle the loan payments. It often helps to do a cost of debt analysis before taking on a loan, to determine how much the debt will cost and whether you’ll be able to utilize the debt to grow your business.
If you want to improve the number you’re seeing in your current assets formula, ask yourself: is there unused equipment that’s sitting around your shop? Or a portion of your office that you’re not using? Sell off or liquidate unused assets to convert them into cash. Doing so will increase your current assets.
When choosing short-term investments, like stocks and bonds, make sure you have a good mix of risk versus return. You want to have a balance of high risk, high return investments and low risk, low return investments. Some banks offer business bank accounts called sweep accounts. These accounts will automatically transfer cash in your bank account that exceeds a specific balance into a higher-interest-bearing account. This also increases your current assets and improves your cash position.
The formula for total current assets is a snapshot of your business’s short-term financial health. When accounting for current assets, here’s what you should keep in mind:
Keep in mind that the formula for total current assets is dynamic, and it’s possible to see improvement pretty quickly in your numbers. Maintaining a good balance of current assets to liabilities will help when applying for business financing, fundraising, and in reaching your day-to-day sales goals.