Evaluating Assets That Will Be Converted into Cash
Businesses have assets - or at least, they should. Assets are anything a business owns. This article explains one type of assets, called current assets. We'll start with business assets and get to current assets shortly.
What Are Business Assets?
Every business has assets, which in their simplest terms are "things of value." Like the actor's smile is her asset, a business needs assets to produce its products or sell its services.
Assets can be tangible, like a piece of equipment or a vehicle, or they can be intangible, like a patent or trademark or copyright.
Business assets are listed on the balance sheet of the business, on the left side. On the right side, the ownership of those assets is explained. Either the owner owns the assets, or they are "owned" by a lender, a bank, or someone else.
What Are the Types of Business Assets?
In terms of the business balance sheet, business assets are categorized by the length of time they are usually held by the business and also by how easily they can be converted to cash.
Cash is the most liquid asset because it already is in a cash form and can be used to make payments easily and quickly. All other assets are listed under cash in the order in which they can be converted to cash. Why is cash so important? Because businesses need it to pay bills and pay employees.
What Are Current Assets?
Current Assets are those business assets that will be converted into cash within one year, and assets that will be used up in the operation of a business within one year. That's the quick definition, for those of you who want the basics. But it's also important to understand the background and importance of current assets to a business.
What Are Current Assets vs. Long-Term Assets?
Knowing the types of assets and how they are categorized helps you to look at the balance sheet of a business and determine its strength.
Current assets, those which can quickly be converted to cash and which are typically held for less than a year, are:
- Cash (for a business, this means the money in the business checking account and any money market accounts)
- Accounts receivable: This term describes amounts owed to the business by customers. It's usually easy to turn receivables into cash.
- Pre-paid insurances. Most insurance is pre-paid, and if the business cancels the policy, it can usually get most of this money back.
- Inventory. It means supplies, parts, and items that can be quickly turned into products to be sold for cash.
Long-term assets, sometimes called capital assets, are more difficult to turn into cash. These assets include equipment, furniture, and fixtures, then land and buildings. Note that land and buildings take the longest to be converted into cash, so they are listed last.
Why Is It Important for Me to Know About Current Assets?
It's important for a business to have assets, and for the business to have some current assets that can quickly be turned into cash if necessary.
How Are Assets Evaluated?
A business is evaluated in several ways based on its assets. Most commonly, those who look at businesses use financial ratios to do these evaluations. Just looking at the numbers isn't as meaningful as looking at the ways the numbers stack up against other numbers.
Two common financial analysis ratios used to evaluate business assets are:
1. Current ratio, which compares current assets to current liabilities. Joshua Kennon, at Investing for Beginners, has a good discussion about current ratio.
2. Quick ratio, which compares only cash and receivables to current liabilities. By leaving out inventory, this ratio is more stringent. It's sometimes called the "acid test" ratio. Rosemary Peavler at Business Finance has a more detailed discussion of quick ratio.