What are current assets and working assets?
Assets
The definition of assets can be found in Art. 3, sec. 1, point 12 of the Accounting Act: these are property resources controlled by an entity (company) with a reliably determined value. They must also meet two conditions:
- they arose as a result of past economic events,
- in the future they will cause an inflow of financial benefits to the entity.
Assets in a company are divided into fixed assets and current assets. The latter, in turn, are divided into tangible assets and financial assets. Let’s start in an unusual way – from the end.
Tangible assets
This concept is explained in Art. 3, sec. 1, point 19 of the Act.
Tangible current assets include:
- materials purchased by an entity for the purpose of consuming them for its own needs,
- finished products (including goods and services) produced or processed by the entity, ready for sale or in the production process,
- semi-finished products and unprocessed goods acquired for resale.
Assets in a company are divided into fixed assets and current assets. The latter, in turn, are divided into tangible assets and financial assets. Let’s start in an unusual way – from the end.
Financial assets (financial working assets)
This definition can be found in Art. 3, sec. 1, point 24 of the Act.
Financial assets include:
- monetary assets,
- equity instruments issued by other entities held by the company,
- rights to receive monetary assets,
- rights to exchange financial instruments with another entity on favorable terms.
Current assets
The explanation of the term can be found in Art. 3, sec. 1, point 18 of the Act.
Current assets include:
- Tangible assets intended for disposal or consumption within 12 months of the balance sheet date or within the operating cycle applicable to the given business activity (if it is longer than 12 months).
- Financial assets payable, due, or intended for disposal within 12 months of the balance sheet date or from the date of their establishment, issuance, or acquisition.
- Short-term receivables, meaning receivables from deliveries and services or from other titles not classified as financial assets, provided they become due within 12 months of the balance sheet date.
- Accruals and deferrals lasting no longer than 12 months from the balance sheet date.
Working capital and current assets – how to understand them?
Working capital is often called working capital and functions as such in English (working capital). The formula for working capital is a company’s current assets minus its liabilities. In other words: the value of working capital indicates the extent to which a company is able to conduct its operations by financing them independently.
What does too low or too high working capital mean?
Low working capital combined with high demand means that the company’s financial liquidity is at risk, and therefore it should seek external financing.
Too high working capital can also prove to be a problem for a company. It is a clear signal that the company is not effectively utilizing the potential of its assets and is not increasing revenue as dynamically as it could.
All of this is particularly important in highly competitive industries – retaining capital in the company often means refraining from investment, and consequently, losing or more slowly gaining a competitive advantage.
What is working capital requirement (WCR) and how to calculate it?
WCR, or working capital requirement, is the demand for working capital. This indicator shows how many resources a company needs to fully cover the costs of:
- the production cycle,
- operating expenses,
- debt repayments.
To correctly calculate the working capital requirement in your company, it is necessary to gather the following data:
- the value of payment liabilities.
- the amount of receivables,
- the value of inventory,
Important!
To ensure the calculations are reliable, specific indicators must be applied to the above data:
- for payment liabilities – the DPO indicator (days payable outstanding).
- for receivables amounts, this will be the DSO indicator (days sales outstanding),
- for inventory, the DIO indicator should be used (days inventory outstanding),
How to increase current assets?
The condition of current assets in a company can be improved in a number of ways. Here are some of the most popular:
Learn optimal inventory management
Try to maintain an inventory level that reduces storage costs, minimizes the risk of expiration (where applicable), while still maintaining full capacity to fulfill orders.
This state is not easy to achieve – it will require extensive internal research and dynamic responsiveness to changes.
- If you run a seasonal business, consider using various logistics models that will allow your company to reduce storage costs – dropshipping and fulfillment are interesting alternatives to standard storage of inventory in your own warehouses, although available to a limited number of industries.
- If you regularly acquire new customers, you need to take this into account and manage inventory in such a way that there is no shortage for carrying out the company’s day-to-day tasks.
- If you are expanding into new markets, try to estimate inventory needs in advance, and then – once operations in the new area have launched – compare the estimates with actual results and adjust inventory levels accordingly.
Negotiate payment terms – both with suppliers and customers
Many entrepreneurs accept so-called business practice without attempting to open a discussion. So if a customer offers to pay within 60 days, claiming that in a given industry “that’s just how it works,” you don’t have to agree.
The negotiating position you start from is not always ideal, but skillfully conducted talks can have a positive impact on your company’s situation and financial liquidity.
Every extension of a payment deadline with a supplier is a real gain for your company – it allows you to effectively manage funds and makes it easier to increase capital. Shortening payment deadlines for customers works in a similar way. If you wait 15 instead of 45 days for payment, you “gain” an extra 30 days to manage that money.
Manage receivables
Do not allow payment delays from your company’s customers. Regularly remind them of upcoming payment deadlines. Send notifications, and if there is no response, contact them directly (e.g. by email or phone).
You can also try an incentive system – for example, preferential contract terms if the customer settles their dues before the deadline.
If none of these solutions bring the expected result, debt collection remains your option. In this context, you can choose one of three paths:
- Use factoring and sell receivables to receive the funds owed immediately – without waiting for repayment.
- Develop procedures that will enable your company to effectively collect debts.
- Look for a debt collection agency that will handle this for you.
Obtain working capital financing
Do you want to increase the working capital available to your company, but none of the previously mentioned methods have worked? Or perhaps their effectiveness turned out to be too low and does not meet your business needs? It is time to turn to external financing. Here are the available options – you can use them independently or together with the methods described earlier.
Factoring
If invoices issued to contractors are still awaiting payment and their deadline is many days away… you can always sell the invoices. Factoring is a good solution for companies that regularly issue invoices with deferred payment terms and do not want to wait for the customer to decide to pay.
Thanks to factoring, your company will receive 80–90% of the funds resulting from the sales document on the same day. The rest will be credited to the account when the contractor settles the payment.
It is an effective solution to financial liquidity problems, but it only works if you have unpaid receivables.
Check what types of factoring are available and which one best suits your company’s needs!
Reverse factoring
Also known as purchase factoring. It is a service through which an entrepreneur can obtain funds for planned business purchases. This solution allows entrepreneurs to make purchases without immediately drawing on their own funds – and thus obtain a deferred payment term for themselves.
Try reverse factoring if you need funds for business purchases!
Working capital loans
Working capital loans granted by banks offer entrepreneurs funds for business development – including investment or environmental purposes. The amount of the loan that can be obtained varies depending, among other things, on the region in which the company operates, the industry, turnover, and many other factors.
Business loans
Although business loans are more often intended for the short term and offer smaller amounts than credits, they have several significant advantages. The most important include: flexibility, simplicity, and speed of execution. Many companies opt for external financing when liquidity problems become considerable – in such a situation, a loan may prove to be a better choice.
It is also worth remembering that most business loans do not specify the purpose for which the obtained funds can be spent.
Using assets as financing collateral
Assets held by an entity can be used to secure a loan or credit. This is a popular solution that enables access to additional funds without the need to liquidate assets.
An entrepreneur using refinancing can spend the funds obtained from the credit or loan, while still retaining ownership of the asset serving as collateral. The condition, of course, is the timely settlement of liabilities towards the lender.
Summary
The importance of current assets in a company is beyond dispute – they determine whether a business can maintain financial liquidity in the face of potential difficulties, changing market conditions, or customer loss.
Proper asset management is a key skill for every entrepreneur – it is worth paying attention to this and regularly optimizing actions in this regard.
