Everything you need to know about current assets
Current assets is a line on a company’s balance sheet that includes cash and other resources with useful life of less than 1 year.
|Current Assets: Definition - Explanation|
|Current||= short-term liquid assets that can be used or liquidated at a fair price in the period of one year or one operating cycle|
|• 12 months from the date of acquisition or the balance sheet date|
|• Fiscal or financial year|
|• One normal operating cycle of a business (even if longer than 12 months)|
|Assets||= resources owned or controlled by an entity for future economic benefit|
|• Cash and cash equivalents|
|• Short-term investments|
|• Accounts receivable|
|• Inventory and supplies|
|• Pre-paid expenses|
|Useful life||= period of time for use in business|
|• Sold or otherwise realized in cash|
|• Consumed, used or otherwise exhausted|
In financial statements, companies may list many different line items under the main category of current assets on their balance sheets.
These sub-categories generally fall into 5 broad groups, sorted from most to least liquid:
When current assets are presented on a balance sheet, they tend to be arranged in their order of liquidity, meaning that the more liquid assets are put on top of the list.
Businesses need cash to run their day-to-day operations.
However, cash does not only refer to the actual currency, coins and paper bills sitting in a cash register, petty cash box, or a bank vault.
Cash equivalents are highly liquid investment holdings that can be converted into known cash amounts fast and with little or no risk.
Petty cash, or petty cash fund, is a small amount of money, typically between $30 and $500, that a business keeps on hand on its premises to pay for ad-hoc business expenses that are too small to warrant writing a check, such as office supplies, meeting refreshments, postage and delivery.
Cash on hand are undeposited receipts of cash, checks and money orders collected from customers as a result of direct cash sales, or when a credit purchase is settled with a cash transaction, that are due to be transferred into petty cash or deposited into a bank account.
Cash-in-bank, or cash-at-bank, current assets refer to the various types of accounts that a business maintains with a financial institution, such as:
When money is deposited with a bank for a term that exceeds 12 months only the current portion (<1 year) is included in current assets. The remaining amount (>1 year) is classified as a long-term investment in the non-current assets section of a balance sheet.
When a business generates excess cash that is not needed for operations or distribution to shareholders, it can either keep the money in a bank account or invest it.
Any short-term investment that has less than 12 months to maturity or is expected to be sold or converted into cash within one year should be classified as a current asset.
While these marketable securities may be a little less liquid than cash, they offer higher rates of return and are heavily traded on public exchanges with buyers being readily available.
Examples of such short-term liquid marketable investment vehicles include:
Accounts receivable include non-trade and trade receivables, with the latter usually making up a significantly larger portion of the total balance displayed under current assets on a balance sheet.
Accounts receivable are payments due from customers for their credit purchases, which are classified as current assets if they are expected to be collected within one year.
For companies offering longer credit terms to customers, the portion of accounts receivable that is due in more than 12 months will not qualify as a current asset.
Accounts receivable also exclude any allowances/provisions for doubtful and bad debts to ensure that current assets reflect the value that the business reasonably expects to receive as some customer accounts may never be recovered (e.g., a customer becomes insolvent), which is a fact of business.
Examples of non-trade receivables include:
Again, only the amount of non-trade receivables that a company expects to collect within one year should be classed as current assets.
Let’s take an example of a car:
The car manufacturer first purchases the raw materials and components from its suppliers, which it then combines with labor and other direct overheads during the car manufacturing process where the work-in-progress vehicles turn into finished cars that are ready to be sold.
Inventories are classified as current assets because stock can be sold relatively quickly.
Nevertheless, inventory is generally the least liquid type of current assets because the process of converting it into cash is usually lengthier and riskier, particularly for some products, business models and industries.
For instance, inventory can become temporarily illiquid or even permanently obsolete because of market fluctuations.
Hence, it is important to maintain optimum stock levels at all times to run business operations efficiently. This is especially true for companies that require large amounts of physical stock, such as those in manufacturing and retail.
Also, keep in mind that the value of inventory is affected by the accounting policies and stock valuation methods used by a company.
Prepaid expenses are classified as current assets when a company makes up-front advance payments for goods and services that it expects to receive within 1 year.
These current assets will turn into expenses when the company actually consumes the goods or services over the course of next year.
Examples include prepaid rent and insurance expenses.
Let’s suppose a company makes an advance payment for an insurance premium that will provide coverage for the upcoming year:
Current assets vary based on the type of business, industry and many additional factors.
As a result, any other business resource satisfying the definition of an asset with a useful life shorter than 1 year should be recorded as a current asset on a balance sheet, even if it does not fall under the most common categories as per above.
Details of other assets are generally provided in the notes to a company’s financial statements.
When you have access to a company’s financial statements, there is no need to calculate current assets because the line item is clearly shown on the balance sheet.
Alternatively, current assets can be calculated in one of two ways, depending on what information you have access to:
1. Add up all of the liquid assets of a company:
2. Deduct a company’s non-current assets from the total value of its assets. According to the accounting equation, assets are equal to liabilities plus equity.
Essentially, current assets represent the dollar value of all the liquid assets and resources that a company can easily turn into cash in a short period of time, which it can then use to pay for business operating costs.
Current assets are used by company management as well as investors, creditors and other stakeholders to evaluate:
Liquidity ratios compare different components of current assets against current liabilities in order to measure a company’s ability to pay its short-term debts and expenses without having to sell other assets or raise external capital.
The proportion of current assets to current liabilities indicates the short-term liquidity of a company because having more current assets than liabilities means that a business is more likely to meet its obligations.
Current ratio is an indicator of liquidity, which measures a company’s ability to meet its short-term obligations using all of its liquid assets, calculated by dividing total current assets by total current liabilities.
Quick ratio, or acid-test ratio, is an indicator of liquidity, which measures a company’s ability to meet its short-term obligations using only its most liquid assets, calculated by dividing near-cash quick assets by total current liabilities.
Quick assets typically include cash and cash equivalents, marketable securities and accounts receivable that can be readily converted to cash within 90 days–but exclude inventory, especially in entities with long inventory cash cycles that result in illiquid stock.
Current ratio is an indicator of liquidity, which measures a company’s ability to meet its short-term obligations immediately using only its cash and cash equivalents, calculated by dividing total cash and cash equivalents by total current liabilities.
Cash equivalents typically include liquid marketable debt and equity securities that mature or can be easily converted to cash within 90 days.
The cash ratio is the most conservative current liquidity ratio as it takes only cash and cash equivalents into consideration, whereas the current ratio is the most accommodating as it includes all types of current assets.
|Current Asset Ratios|
|(= Current Assets ÷ Current Liabilities)|
|Ratio||Formula Numerator||Liquidity Measure|
|Current ratio||Total current assets||All liquid assets|
|Quick ratio||(Current assets – Inventory)||Only the most liquid assets convertible to cash within 90 days|
|Cash ratio||(Cash + Cash equivalents)||Only cash and cash equivalents|
Current assets are also a key component of a company’s working capital, which is used to fund daily business operations and calculated as the difference between current assets and current liability:
While current assets are an effective measure of a company’s liquidity and its ability to meet financial obligations, there are some inherent limitations:
Some of current assets may become illiquid when, for example:
Hence, the contents of current assets need to be carefully examined to establish the true liquidity of a company and ensure it is not overstated.
Excessive accumulation of current assets may lead to increased cost of business due to the time value of money and opportunity cost.
On the other hand, lack of current assets (e.g., inventory) may disrupt operations and result in the loss of business opportunities.
Therefore, maintaining current assets at an optimal level is vital for any company.
Inconsistent accounting methods, payment cycles and other company specific factors make it challenging to compare current asset portfolios of different companies. Keep this in mind when analyzing a company’s financial statements.
In bookkeeping, an increase in current assets is shown on the debit side of an account, whereas decrease is recorded as a credit.
|Current Assets: Debits & Credits|
In financial statements, current assets are reported on the balance sheet as of a specific date, being presented first on top of the assets section and arranged in order of liquidity.
When a current asset is used or sold, the transaction is captured in the income statement for the period (e.g., COGS; expenses).
For example, when a company sells a product to a customer, the inventory used is recorded as COGS (cost of goods sold) on the income statement.
The correct accounting definition, measurement, recognition and disclosure of current assets is guided by the accounting standards and other regulatory requirements applicable in your specific circumstances (e.g., geographic region, company structure).
For example, the IFRS (International Financial Reporting Standards) Conceptual Framework for Financial Reporting defines an asset as:
“An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. [F 4.4(a)]”
Assets are the resources owned by a company in order to run and grow its business.
There are two main types of assets on a company’s balance sheet: current assets and non-current assets. Within these two categories, there are many subcategories and line items.
Current assets are generally listed at the very top of a balance sheet, followed first by the non-current assets and then the combined total asset balance.
|Balance Sheet: Company X|
|Cash and Cash Equivalents||1,000,000|
|Other Current Assets||1,000,000|
|Total Current Assets||5,000,000|
|Property, Plant and Equipment||1,000,000|
|Accumulated Depreciation and Amortization||1,000,000|
|Other non-current assets||1,000,000|
|Total non-current assets||7,000,000|
Current assets are short-term liquid resources that a company uses to run its daily operations and pay for immediate expenses because they are easily convertible to cash within a year.
Examples of current assets include:
Non-current assets, also known as long-term or capital assets, are resources that are expected to be held for more than one year as they have a useful life of more than 12 moths and cannot be readily turned into cash.
Non-current assets are used for the long-term needs of a business and include both tangible and intangible resources:
|Differences Between Current and Non-current Assets|
|Difference||Current Assets||Non-Current Assets|
|Also known as||Short-term assets, liquid assets||Long-term assets, capital assets|
|Examples||Cash, cash equivalents, short-term marketable investments, accounts receivable, inventory and supplies, prepaid expenses||Tangible fixed assets (e.g., land, property, heavy equipment, vehicles), long-term investments, long-term deferred charges (e.g. taxes), intangible non-physical assets (e.g., patents, trademarks, copyrights, goodwill), depreciation and amortization|
|Use||Funding of current, immediate, day-to-day and short-term business needs||Funding of future and long-term needs|
|Liquidity||Equal to cash or convertible into cash within a year||Not expected to be converted into cash within one year|
|Balance sheet presentation||Listed at the top of a balance sheet and arranged according to liquidity||Listed below current assets|
|Valuation||Market value at market prices||Cost less depreciation or amortization|
|Revaluation||Revaluation is not common (but some current assets, like inventory, may be revalued)||Revaluation is common|
|Tax||Sales profit from trading activities||Capital gains|
Land is not a current asset because current assets are short-term, liquid and marketable economic resources that a business can use or readily convert to cash within 1 year. Rather, land is a non-current asset, which is a long-term resource with a useful life of more than 12 months.
Inventory is a current asset because current assets are defined as short-term liquid economic resources that a business uses to run its daily operations and pay for immediate expenses because they are easily convertible to cash within one year.
The list of non-current asset, or capital asset, examples includes:
The list of current assets examples includes:
There are three formulas to calculate current assets:
1. Current Assets = Total Assets – Non-Current Assets
2. Current Assets = (Liabilities + Equity) – Non-Current Assets
3. Current Assets = Cash + Cash Equivalents + Short-Term Investments + Accounts Receivable + Inventory + Pre-Paid expenses + Other Liquid Assets
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