Assets are anything of value that is owned by a company, whether fully paid for or not. These range from cash, inventory, and other “current assets” to real estate, equipment, and other “fixed assets.” Intangible items of value to a company, such as exclusive use contracts, copyrights, and patents, are also regarded as assets.
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Also known as soft or liquid assets, current assets include cash, government securities, marketable securities, notes receivable, accounts receivable, inventories, raw materials, prepaid expenses, and any other item that could be converted to cash in the normal course of business within one year.
Cash is, of course, the most liquid of assets. But in business circles, the definition of cash is expanded beyond currency (coins and paper money) to include checks, drafts, and money orders; the balance in any company checking account (provided there are no restrictions attached to the account); and even less liquid assets that are nonetheless commonly regarded as cash equivalents. These include certificates of deposit (CDs) with maturities of less than a year, money market funds, and Treasury bills.
For many small businesses, cash comprises the bulk of their current assets. Cash is flexible and can be quickly and easily converted into needed goods or services. But the very ease with which it can be used makes it attractive for disreputable people both within and outside the business, so small business owners need to make sure that they take the appropriate precautions when handling such assets. Consultants often recommend that their clients take out insurance policies to protect themselves from financial losses as a result of employee theft or error; this practice is commonly known as “bonding.”
Another important practice that helps to safeguard current assets has to do with dividing up tasks. To reduce the likelihood of any one malicious individual being able to rob or embezzle from a company it is useful to have different people in charge of tracking both receipts and disbursements. Splitting up the responsibilities for handling cash, bookkeeping, and bank statement reconciliation is an easy way to be sure that various people are all monitoring current assets. In small businesses these tasks are often, and understandably, handled by one individual. Having at least two people involved in these tasks on a regular basis increases the chances that errors, whether intentional or not, are found and remedied in a timely fashion.
The use of a petty cash fund is a practical way to provide for small outlays without exposing a larger percentage of a company’s current liabilities. While small businesses may not be able to institute the elaborate systems used in larger enterprises, cash control is important.
Accounts receivable is another type of current asset.
Accounts receivables are sums owed to the company for services or goods rendered. Inventories are important current assets as well, particularly for business firms engaged in manufacturing and merchandising.
Inventories typically held by merchandisers include finished goods ready for sale or resale, while the inventories of manufacturing establishments can include raw materials, supplies used in manufacture, partially completed work, and finished goods.
Also known as hard assets, fixed assets include real estate, physical plants and facilities, leasehold improvements, equipment (from office equipment to heavy operating machinery), vehicles, fixtures, and other assets that can reasonably be assumed to have a life expectancy of several years. Most fixed assets, with the notable exception of real estate, will lose value over time. This is known as depreciation, and is typically figured into a business’s various financial documents (the expense of real estate purchases can also be depreciated when figuring taxes).
Small business consultants note, however, that this depreciation can be figured by several different formulas. The smart business owner should take the time to figure out which formula is most advantageous for his or her company.
Fixed assets are among the most important assets that a company holds, for they represent major investments of financial resources. Indeed, fixed assets usually comprise the majority of a business’s total assets.
Intelligent allocation of resources to meet a business’s land, facility, and large equipment needs can bring it assets that will serve as cornerstones of successful operation for years to come. Conversely, a company saddled with ill-considered or substandard fixed assets will find it much more difficult to be successful. This is especially true for small businesses, which have a smaller margin of error.
Fixed assets are also very important to small business owners because they are one of the things that are examined most closely by prospective lenders. When a bank or other lending institution is approached by a small business owner who is seeking a loan to establish or expand a company, loaning agents will always undertake a close study of the prospective borrower’s hard assets. Bankers view these fixed assets as a decisive indicator of a business’s financial health.
When examining a business’s fixed assets, lenders are typically most concerned with the following factors: 1) The type, age, and condition of equipment and facilities; 2) The depreciation schedules for those assets; 3) The nature of the company’s mortgage and lease arrangements; and 4) Likely future fixed asset expenditures.
Risky Vs. Riskless Assets
The monetary flow that a business owner receives from an asset can vary because of many different factors. When comparing the value of various assets, the monetary flow of an asset is an important consideration, especially relative to the asset’s value or price. A risky asset provides a monetary flow that is at least in part random, in other words, the monetary flow isn’t known with in advance. A “riskless” asset, on the other hand, is one that features a known level of monetary flow to its owner. Bank savings accounts, certificates of deposit (CDs), and Treasury bills all qualify as riskless assets because the monetary flow of the asset to the owner is known. Finally, the “return” on an asset—whether risky or riskless—is the total monetary reward it yields as a fraction of its price.
Asset Utilization Ratios
A financial ratio is a simple mathematical comparison of two or more entries from a company’s financial statements. Business owners and managers use ratios of all sorts to chart a company’s progress, uncover trends and point to potential problems. Bankers and investors look at a company’s ratios when they are trying to decide whether or not to invest or lend to the company.
The asset utilization ratio is a measure of the speed at which a business is able to turn assets into sales, and thus, revenue. The use of ratio analysis, especially with a small company, is of greatest value when done over time to chart changes in the company’s performance and compare the company’s performance with others within the same industry.
The four primary asset utilization ratios are: 1) Receivables turnover, which studies the number of times that receivable balances are collected annually; 2) Inventory turnover, which is determined by dividing the annual cost of sales by the average inventory at both the beginning and the end of the period being studied; 3) Fixed asset turnover; and 4) Total asset turnover. Asset turnover ratios measure the efficiency with which a company uses its assets to generate sales.
The higher the turnover ratio, the more efficient the company. Fixed asset turnover ratios are not particularly useful to compute if the company under examination does not have a significant amount of hard assets, frequently true with small, new and/or serviceoriented businesses.
See also: Liabilities