Effective management of a business current assets is necessary for a business survival. Why? For a business to remain in operation, it must ensure there are funds available to meet current obligations. These obligations include payment of debts, having enough cash to meet day-to-day expenses, payments of staff salary and of course regular supply of inventory.
Definition of current assets
I have earlier defined current assets. It is those assets that are available in a business within a year or an operating cycle whichever is higher.
Current assets are also called gross working capital or circulating capital. Examples are: inventory, cash and cash equivalent and account receivables.
Skills required in managing current assets
To effectively manage current assets, two skills are involved. Optimising investment in current assets and financing current assets.
Optimal investment of current assets
Management must ensure that the availability of current assets is just right for the entity. This means that it should not be excessive nor be inadequate. The rule of thumb to know if a current asset is optimal is the ratio 2:1 for current asset ratio. The formula for calculating this ratio is current assets ÷ current liabilities.
If the ratio is higher than 2:1 say 2.1:1 or 3:1, then it can be said that the current asset is excessive for the firm. However, if it is lower, say 0.8:1, then it is grossly inadequate. Therefore, management must have a microscopic view of its current assets.
Excessive investment in current assets must be avoided because it impairs the business performance in terms of profit. This is true! Investments that are idle will not yield any return. For example, having too much cash in the vault of the entity, will not provide further income to the business. Also, storing up too many inventories may not increase the business sales, leading to no increase in profit.
On the other hand, inadequate investment in current assets can be dangerous. It may lead to solvency issues. And the entity may lack the ability to meet current obligations such as paying debts; and wages and salaries. Even stocking up inventories in a boom period. This may lead to the end of a business or loss of customers.
Financing Current Assets
There are needs to adequately finance current assets. This will ensure availability of working capital at any point in time. The management, especially the finance manager or chief finance officer (CFO) must have knowledge of the sources of funds available to finance current assets.
These sources include and are not limited to loans from banks, commercial papers, investment in shares of other entities, treasuring bills, mutual funds and dollar funds. There may be the need to invest excess cash on these sources of funds or withdraw the investment to meet current operating obligations.
In every organisation, there are periods in which are excesses or surplus of current assets. And when there are inadequate or the need for working capital. During the periods of less demand for the firm’s products or services, idle cash may be available. This surplus can be invested in short term investments like treasury bills or mutual funds. However, in the periods of increasing business activities the funds already saved or invested can be withdrawn to meet the demands from customers.
To wrap it up, management especially CFOs must know the sources of funds available to fund current assets or gross working capital. Also, there should be a microscopic view of the entity’s current assets. This will help avoid the fluctuations that arise from this important aspect of a business.