Assets circulating

3 key takeaways

• Circulating assets are short-term assets expected to be converted into cash or used up within one year.
• They include cash, accounts receivable, inventory, and other liquid assets.
• Effective management of circulating assets is crucial for maintaining business liquidity and operational efficiency.

What are circulating assets?

Circulating assets, or current assets, represent the assets of a company that are likely to be converted into cash or consumed in the near term, typically within a year. These assets are vital for the smooth operation of a business as they provide the necessary resources to cover short-term liabilities and operational costs. Common examples include cash, accounts receivable, inventory, and short-term investments.

Importance of circulating assets

Circulating assets are critical for maintaining the liquidity and operational health of a business. They ensure that a company has enough resources to meet its short-term financial obligations, such as paying suppliers, covering payroll, and managing other day-to-day expenses. Proper management of circulating assets helps in optimizing working capital and sustaining business operations.

How circulating assets work

Cash and cash equivalents: These are the most liquid assets, including physical cash, bank balances, and short-term investments that can be quickly converted into cash. They provide immediate liquidity for the business.

Accounts receivable: These are amounts owed to the business by customers for goods or services delivered on credit. Accounts receivable are expected to be collected within a short period, typically 30 to 90 days.

Inventory: This includes raw materials, work-in-progress, and finished goods that a company holds for sale. Inventory is expected to be sold and converted into cash within the business’s operating cycle.

Short-term investments: These are investments that can be easily liquidated within a year, such as marketable securities and treasury bills. They offer liquidity and can be used to generate additional income.

Prepaid expenses: These are payments made in advance for goods or services to be received in the future, such as insurance premiums or rent. Prepaid expenses are considered circulating assets as they will be used up within the year.

Examples of circulating assets

• Retail business: A retail store holds inventory of clothing items, maintains cash registers with cash, and has accounts receivable from customers who purchased on credit. These are all circulating assets.
• Manufacturing company: A manufacturing firm has raw materials, work-in-progress inventory, and finished goods ready for sale. It also has cash balances and accounts receivable from distributors. These assets are part of the company’s circulating assets.
• Service provider: A consulting firm has cash in the bank, accounts receivable from clients, and prepaid office rent. These assets are expected to be converted into cash or used up within a year.

Real-world application

Consider a small manufacturing company that needs to manage its circulating assets effectively to ensure smooth operations. The company has:

• $50,000 in cash and cash equivalents.
• $100,000 in accounts receivable from customers.
• $150,000 in inventory, including raw materials, work-in-progress, and finished goods.
• $20,000 in short-term investments.
• $10,000 in prepaid expenses, such as insurance and rent.

To maintain liquidity and meet its short-term obligations, the company regularly monitors and manages these circulating assets, ensuring timely collection of receivables, efficient inventory turnover, and strategic use of cash and short-term investments.

Understanding circulating assets is essential for financial management and operational efficiency. Businesses need to manage these assets carefully to maintain liquidity, meet short-term obligations, and ensure smooth day-to-day operations.

Related topics you might want to learn about include working capital management, liquidity ratios, and cash flow management. These areas provide further insights into effective management of short-term assets and financial health.