By Hashaw Updated September 29, 2020
Cash on a balance sheet includes currency, bank accounts and undeposited checks. It is necessary to keep some cash available in case of unforeseen expenses. Cash is reported in the "current assets" portion of the balance sheet. Monitoring cash balances over time is a way of measuring business health and solvency. Lenders and investors often take a great deal of interest in a company's available cash flow because it indicates whether the company can meet liabilities or issue dividend payments.
Why Is Cash Important?
Cash can indicate the health of a business, advises the BBC. Cash levels represent a company's ability to pay its bills or debts. A growing balance of cash over time may indicate higher sales or increased productivity. Comparing cash balances against the cash levels at similar businesses helps assess relative business health. Lower cash levels over time can indicate the opposite and warn of impending insolvency. Cash is always considered a current asset for accounting purposes.
Increased cash levels can be spent, saved, given to charity, reinvested in the company, or distributed as dividend payments. Cash levels can be negatively affected by the timeliness of payments by customers and periods of intense growth. Startups commonly have low cash balances because a lot of capital is required to start a business.
Companies with low debt and high levels of current assets are said to have a "fortress balance sheet." The exception occurs when a company's cash balance is high due to borrowed money. Sometimes, businesses pad their current assets with borrowed money to appear more attractive to investors. High levels of borrowed cash is a sign of poor business health.
What Are Current Assets?
Current or short-term assets are those that can be converted into cash within a single year. Current assets are essential for meeting short-term business needs. Current assets are usually found at the top of a balance sheet. These are resources necessary for running daily operations and paying bills. Current assets can include cash and equivalents, accounts receivable, prepaid expenses, inventory and marketable securities. Cash and cash equivalents may include bank accounts that contain cash, savings bonds, certificates of deposit (CDs) and money market funds.
Non-current assets are those that have a useful life beyond one year, typically long-term investments that are not as liquid as current assets. For example, inventory is considered a current asset because it is expected to be converted into profit within a year. Equipment is an example of a non-current asset because it is used for several years and depreciated or amortized over time.
How to Calculate the Cash Balance of Current Assets
Cash levels are a critical factor for numerous ratios that indicate the health of a business and current assets. The cash ratio and quick ratio, or "acid test," are important formulas for determining a company's ability to pay short-term liabilities, according to Corporate Finance Institute. The cash ratio determines whether a company can meet liabilities without liquidating or selling assets. The acid test indicates how much cash a company can access within 90 days.
Using these ratios requires knowing how to calculate cash levels from the balance sheet when necessary. First, find the non-cash items in the current assets section of the balance sheet. Non-cash items include short-term investments, accounts receivable, inventory and supplies, according to Sapling. Add the total amount of current non-cash assets together. Next, find the total for all current assets at the bottom of the current assets section. Subtract the non-cash assets from the total current assets. This number represents the amount of cash on the balance sheet.
As an expert in accounting and finance, I bring a wealth of knowledge and hands-on experience to shed light on the intricacies of small business accounting, specifically focusing on the crucial aspect of managing cash on a balance sheet. My background includes a comprehensive understanding of financial statements, ratios, and the strategic implications of cash management for business health.
Now, let's delve into the concepts presented in the provided article:
Cash on a Balance Sheet:
The article rightly emphasizes that cash on a balance sheet encompasses not just physical currency but also bank accounts and undeposited checks. It's positioned as a "current asset," residing in the current assets portion of the balance sheet. This classification is crucial for assessing a company's ability to meet short-term obligations.
Importance of Cash:
The piece underscores the importance of cash as a key indicator of business health. Monitoring cash levels over time provides insights into a company's solvency and its capacity to pay bills or debts. Lenders and investors closely scrutinize cash flow, using it as a gauge for the company's financial viability and ability to issue dividends.
Factors Influencing Cash Levels:
The article touches upon various factors affecting cash levels, such as the timeliness of customer payments, periods of intense growth, and the nature of startups. It notes that companies with low debt and high current assets are deemed to have a "fortress balance sheet," but caution is warranted if high cash balances result from borrowed money.
Current Assets:
The distinction between current and non-current assets is clarified. Current assets are those convertible to cash within a year and include cash and equivalents, accounts receivable, prepaid expenses, inventory, and marketable securities. This section provides a comprehensive view of resources necessary for daily operations.
Calculating Cash Balance of Current Assets:
The article introduces critical financial ratios like the cash ratio and quick ratio (acid test) for assessing a company's ability to meet short-term liabilities. The method for calculating the cash balance from current assets involves identifying non-cash items, adding them up, and subtracting this total from the overall current assets to arrive at the cash amount.
In conclusion, the provided information offers a holistic view of managing cash on a balance sheet, emphasizing its pivotal role in determining a company's financial health and its implications for short-term obligations and strategic decision-making.
