Accounts receivable refers to the money your customers or partners owe you. For instance, if you're a marketing agency, your accounts receivable consists of the invoices you've sent customers. Accounts receivable isn't the money you've collected from your customers or clients; it's the amount owed to you that they haven't paid yet.
Accounts receivables allow customers to make purchases on credit. If you supply a business with a product or service, you may allow them a specific payment period, like net 30. These customers agree to pay at a later date, so businesses must issue invoices, monitor payment due dates, and follow up for timely payments.
Even though accounts receivable isn't actually cash in your pocket yet, you can assume your invoices will be paid on time within a short period, making them a current asset.
If your business sells products, your inventory may qualify as a current asset. Raw materials and unsold goods are considered liquid because they can easily be sold within a period of a year. Your inventory is less liquid than other investments because it takes more work to sell, but it could be a valuable resource when you need to improve cash flow.
Your inventory is converted to cash by selling it to customers, and the faster you sell, the more you can earn. In addition, inventory is expected to be sold within a short period and is a significant business investment.
Prepaid expenses are typically fixed or variable costs you benefit from. They're current assets because they're costs that have already been paid and will be used within the next year. Examples of prepaid expenses that can be classified as current assets include:
All these prepaid expenses are current assets because they're expenditures that have already been paid but will be used in the near future.
Short term investments
Short-term investments are technically cash equivalents and marketable securities because they're converted into cash within a short period. These investments are considered liquid because you can convert them to cash whenever necessary and allow the business to passively earn a return on their investment.
Short-term investments like stocks, bonds, and mutual funds appreciate over time and can help companies preserve capital while diversifying their investment portfolios for an additional layer of protection.
Other liquid assets
Other liquid assets are any that can be converted into cash within a year and don't fit into any other categories. Examples of other liquid assets include the following:
- Marketable commodities: If marketable securities are investments that can be quickly converted to cash, marketable commodities are items that can be quickly converted to cash. Marketable commodities include precious metals, oil, and other products you can sell quickly to generate cash.
- Trade discounts: Trade discounts can't directly convert to cash, but they increase a company's liquidity by reducing overall costs.
- Restricted cash: Restricted cash is cash set aside for a specific purpose. While it has a specific purpose, it's still considered a liquid asset because it can be used anytime.
- Advances to supplies: Advances are payments made in advance for goods or services your business needs to operate. You and the supplier agree that payment is provided now while the goods and services are provided at a later date. Paying now can help you secure better pricing or a particular product when it's available. Advances qualify as current assets because they're prepaid expenses.
- Deposits: Deposits are a guarantee for a future transaction. Your business receives the deposit now in exchange for certain assurances in the same way a landlord asks for a security deposit when you rent a home.
Why are current assets important for a business?
Current assets are important because they provide liquidity that streamlines your business processes and ensures businesses can sustain operations while meeting their goals. Current assets cover immediate and short-term expenses, allowing businesses to pay suppliers and employees while keeping them covered during emergencies.
Maintaining liquidity protects businesses, frees up cash flow for time-sensitive costs, and makes them better equipped to seize growth opportunities while navigating periods of economic downturn. Here are a few ways current assets benefit your business:
Helps a business perform its daily operations
Current assets like cash, accounts receivable, and inventory ensure the business runs smoothly on a daily basis. All businesses need cash to pay for immediate expenses.
Still, accounts receivable gives you an idea of the amount of money you'll have in the near future, allowing you to plan ahead. Meanwhile, inventory ensures you have enough products to meet customer demand and generate cash flow.
Ensures you can cover routine expenses
All businesses have routine expenses like rent, payroll, tools, inventory, machinery, and so forth. Current assets ensure you have the cash flow to cover these expenses on time. The cash generated from current assets allows you to maintain good financial health and relationships with suppliers while avoiding disruptions in operations.
For example, if you run out of inventory, you can't sell products, meaning you won't generate cash. At the same time, your operations can come to a standstill because your employees won't have anything to do if they're not filling orders and communicating with customers.
Helps with capital management
Working capital is the money available to fund your day-to-day operations and is the difference between a company's current assets and liabilities. By managing accounts receivable, cash, and other current assets, your business can avoid cash flow problems while maximizing profitability.
Contributes to a company's financial stability
Current assets contribute to your business's financial stability because they represent your liquidity and how much money you have available to use. Having enough current assets ensures you can meet your financial obligations while maintaining a positive cash flow and sustainable growth.
Good financial stability is key if you want to maintain a good reputation and attract investors or take out a business loan. In addition, knowing your business is financially healthy can reduce your stress, allowing you to focus less on worrying about money and more on growing your business.
Plays a crucial role in decision-making
Making data-driven decisions is crucial if you want your business to grow. Current assets can help you monitor your liquidity to assess the overall financial health of your company, identify trends, and make better decisions about pricing, production, marketing, and allocating resources.
In addition, understanding your current assets can free up more cash for growth opportunities to take your business to the next level, such as entering new markets, expanding across borders, or acquiring new businesses.