A current asset happens to be an account of a balance sheet that will represent the value of all your assets that may be converted into cash during a single year. Current assets may include cash equivalents, cash, inventory, accounts receivable, prepaid expenses, marketable securities, and even other liquid assets which may be converted into cash.
However, in the United Kingdom, current assets are actually called current accounts.
Current assets are vital to a business because they are able to be used to fund the daily operations as well as pay for any ongoing expenses. Depending on what the business is, current assets may range from baked goods, to crude oil to foreign currency. Whenever you look at a balance sheet, the current assets will normally be displayed under liquidity, which is the easy in which they may be turned into cash.
Assets that are not easily converted into cash within a year or during a businesses operating cycle, if it is longer are not actually included within this category and are actually considered to be long term assets. These will often depend on the nature of the business, but it may include facilities, copyrights, land, equipment and other types of liquid investments.
Main parts of Current Assets
Accounts receivable are bills to customers that have not been paid yet, and they are considered to be current assets as long as they may be expected to be paid within a single year. If a business has been making sales by offering loose credit terms, then a majority of the accounts receivables may not come due for a longer time period. It is even possible that some accounts may never be paid in full. This consideration is often reflected in allowances for doubtful accounts, which is then subtracted from the accounts receivable. If the account is never collected, then it is written as being a bad debt expense.
Inventory will also be included in current assets, but this should be taken as a grain of salt. Various accounting methods may be used to inflate inventory, and in some cases, it isn’t as liquid as other types of current assets. It may not even be as liquid like accounts receivable, which may be sold to third party collection agencies, however it is a steep discount. Inventories will often tie up capital and it will demand shifts unexpectedly, which is very common in many industries when compared to others, inventory can then become backlogged. Healthy current asset balance can actually obscure weak inventory turnover ratios and any other issues.
Prepaid expenses are often considered to be current assets not because they can be turned into cash, but because they have already been taken care of which frees up cash for any other use. While the year goes on, the value of the prepaid expenses as an asset will decrease and they will become amortized in order to reflect this. Prepaid expenses may include payments to contractors or insurance companies.
Ratios with Current Assets
The components of any current assets are often used to calculate the number of ratios that may be related to the liquidity of a business. The cash ratio will be the most conservative as it divides cash equivalents and cash by current liabilities and will then measure the ability of a company to be able to pay off all of the short-term liabilities right away.
The quick ratio is going to be less stringent as it will add cash equivalents and cash, accounts receivable and marketable securities and then will divide them by the current liabilities. This particular ratio doesn’t classify inventory as a quick asset and so it will not include it in the calculation. This often will provide a more realistic picture a business’ ability to meet the short-term obligations, but it may be skewed due to backlogs of accounts receivable.
The current ratio may be the most accommodating which is dividing current assets by the current liabilities. It needs to be noted that in addition to any accounts receivable that this measure will often include inventories, so it may overstate the liquidity in most cases, especially for a retailer and other inventory intensive companies.
When it comes to personal finance, the current assets will include cash in the bank and on hand, as well as your marketable securities that are not tied up any long-term investments. Basically, current assets are going to be anything that is of value that is highly liquid. Current assets may even be used to pay any outstanding debts and cover liabilities without you having to sell any fixed assets.
Current assets are important because they will indicate just how much cash a business has access to within a single year outside of any third-party sources. It will indicate how the business funds are going to go during day to day operations and jut how liquid the business is. The ratio of current assets to any current liabilities are very important when it comes to judging the liquidity.
Formula for calculating current assets
It is very easy to calculate your current assets. However, it is vital that you make sure that all the assets are considered current will be included into the calculation, since there are many. Below is the formula and then an example showing you how to calculate your current assets.
The formula for your current assets is as follows:
Current Assets =
(Accounts Receivable) + (Marketable Securities) + (Cash equivalents & Cash) + (Inventory) + (Prepaid Expenses) + (Other Liquid Assets)
In order to calculate your assets, you will need to add up your short-term assets that may be converted into cash within a single year. Check out this example to understand it much better.
Let’s say for instance that your business’s short-term assets may include these on your asset sheet:
Accounts Receivable: $40,000
Marketable Securities: $150,000
Cash equivalents & Cash: $120,000
Prepaid Expenses: $20,000
Based on the data that is listed above, the short-term assets will be calculated as follows:
$40,000 + $150,000 + $120,000 + $75,000 + $20,000 = $405,000