What are current assets?
Current assets represent all of a company’s assets that are expected to be conveniently sold, consumed, used, or depleted through standard business operations in a year. Current assets appear on a company’s balance sheet, one of the required financial statements that must be completed each year.
Current assets would include cash, cash equivalents, accounts receivable, inventory of shares, marketable securities, prepaid liabilities and other liquid assets. Current assets can also be called current accounts.
- Current assets are all assets of a company that are expected to be sold or used as a result of standard business operations in the coming year.
- Current assets include cash, cash equivalents, accounts receivable, inventory of shares, marketable securities, prepaid liabilities and other liquid assets.
- Current assets are important to businesses because they can be used to finance day-to-day business operations and to pay for ongoing operating expenses.
Understanding of current assets
Current assets are contrasted with long-term assets, which represent assets that cannot be converted to cash in the space of one year. They generally include land, facilities, equipment, copyrights, and other illiquid investments.
Current assets are important to businesses because they can be used to finance day-to-day business operations and to pay for ongoing operating expenses. Since the term is reported as a dollar value of all assets and resources that can be easily converted to cash in a short period, it also represents the liquid assets of a company.
However, care must be taken to include only qualifying assets that can be liquidated at the right price over the next one-year period. For example, there is a high probability that many commonly used fast-moving consumer goods (FMCG) produced by a company will be able to sell easily over the next year. Inventory is included in current assets, but it can be difficult to sell land or heavy machinery, so these are excluded from current assets.
Depending on the nature of the business and the products it markets, current assets can vary from barrels of crude oil, manufactured products, inventory of works in progress, raw materials or foreign exchange.
Key components of current assets
Cash, cash equivalents, and liquid investments in marketable securities, such as short-term interest-bearing bonds or Treasuries, are obvious inclusions in current assets. However, the following are also included in current assets:
Accounts receivable, which is money owed to a business for goods or services delivered or used but not paid by customers yet, are considered current assets as long as they are expected to be paid within a year. If a business makes sales by offering longer credit terms to its customers, a portion of its accounts receivable may not qualify for inclusion in current assets.
It is also possible that some accounts are never paid in full. This consideration is reflected in a provision for doubtful accounts, which is subtracted from accounts receivable. If an account is never collected, it is recorded as a bad debt expense and those entries are not considered current assets.
Inventory, which represents raw materials, components, and finished goods, is included as a current asset, but consideration of this item may require careful analysis. Different accounting methods can be used to inflate inventory, and sometimes it may not be as liquid as other current assets, depending on the product and industry sector.
For example, there is little or no guarantee that a dozen units of high-cost heavy earthmoving equipment will be sold over the next year, but there is a relatively higher probability of a successful sale of a thousand umbrellas in the next marketing season. rains. . Inventory may not be as liquid as accounts receivable and locks in working capital. If demand changes unexpectedly, which is more common in some industries than others, inventory can build up.
Prepaid expenses, which represent advance payments made by a company for goods and services that will be received in the future, are considered current assets. Although they cannot be converted into cash, they are payments already made. These components free up capital for other uses. Prepaid expenses could include payments to insurance companies or contractors.
On the balance sheet, current assets are normally shown in order of liquidity; that is, the items that are most likely to be converted to cash are ranked higher. The typical order in which current assets appear is cash (which includes currency, checking accounts, and petty cash), short-term investments (such as liquid marketable securities), accounts receivable, inventory, supplies, and prepaid expenses.
The formula for current assets
Therefore, the current asset formulation is a simple sum of all assets that can be converted to cash within a year. For example, looking at the balance sheet of a company, we can add:
Current assets = C + CE + I + AR + MS + PE + OLAwhere:C = cashCE = Cash equivalentsI = InventoryAR = Accounts receivableMS = Marketable securitiesPE = Expenses paid in advanceOLA = Other liquid assets
Real world example
Walmart Inc.’s Leading Retailer (WMT) total current assets for fiscal year 2021 is the total sum of cash ($ 17.74 billion), total accounts receivable ($ 6.52 billion), inventory ($ 44.95 billion), and other current assets ($ 20.86 billion), amounting to $ 90.07 billion.
By comparison, for fiscal 2021, Microsoft Corp. (MSFT) had cash and short-term investments ($ 130.33 billion), total accounts receivable ($ 38.04 billion), total inventory ($ 2, 64 billion) and other current assets ($ 13.39 billion). Therefore, the technology leader total current assets it was $ 184.4 billion.
Uses of current assets
The total current assets figure is of utmost importance for the management of the company with respect to the daily operations of a company. As bill and loan payments are due at the end of each month, management must be ready to spend the necessary cash. The dollar value represented by the total current assets figure reflects the cash and liquidity position of the company and allows management to prepare for the necessary arrangements to continue business operations.
Additionally, creditors and investors closely monitor a company’s current assets to assess the value and risk involved in its operations. Many use a variety of liquidity ratios, representing a class of financial metrics that are used to determine a debtor’s ability to pay its current debt obligations without raising external capital. These commonly used indices include current assets (or parts thereof) as a component of their calculations.
Financial ratios that use current assets or their components
Due to the different attributes associated with business operations, different accounting methods, and different payment cycles, it can be challenging to correctly categorize components as current assets within a given time horizon. The following ratios are commonly used to measure the liquidity position of a company. Each index uses a different number of components of current assets versus current liabilities of a company.
- The current ratio measures the ability of a company to pay short and long-term obligations and takes into account the total current assets (both liquid and illiquid) of a company in relation to current liabilities.
- The quick index measures the ability of a company to meet its short-term obligations with its most liquid assets. Consider cash and equivalents, marketable securities, and accounts receivable (but not inventory) against current liabilities.
- The cash ratio measures a company’s ability to settle all of its short-term liabilities immediately and is calculated by dividing cash and cash equivalents by current liabilities.
While the cash ratio is the most conservative ratio, since it only takes into consideration cash and cash equivalents, the current ratio is the most accommodative and includes a wide variety of components for consideration as current assets. These various measures are used to assess the company’s ability to pay outstanding debts and cover liabilities and expenses without having to sell fixed assets.
Why are current assets “current”?
Current assets are assets that can be converted to cash within a fiscal year or operating cycle. Current assets are used to facilitate investments and day-to-day operating expenses. As a result, short-term assets are liquid, which means they can easily be converted into cash and used to pay short-term past due bills and obligations.
What are some examples of current assets?
Current assets can be found on a company’s balance sheet. Common examples of current assets include:
- Cash and cash equivalents, which may consist of cash accounts, money markets, and certificates of deposit (CDs).
- Marketable securities, such as stocks (stocks) or debt securities (bonds) that are publicly traded and can be sold through a broker.
- Accounts receivable or money owed to the company for selling its products and services to its customers.
- The inventory or goods that have been produced are ready for sale.
- Prepaid expenses for goods or services to be received in the near future.
How are current assets different from fixed (non-current) assets?
Fixed assets, also known as non-current assets, are intended for longer-term use (one year or more) and are not usually easily liquidated. As a result, unlike current assets, fixed assets are subject to depreciation, that divides the cost of non-current assets of a company to spend them during its useful life.
How are current assets used in financial analysis?
Managers, analysts, and investors will look at the position of a company’s current assets, especially relative to current liabilities, to determine if the company has sufficient liquidity to meet its short-term obligations, such as payroll and invoices. Various liquidity ratios, such as the quick ratio and the current ratio, can be used for this purpose (where the higher the ratio the better).