What are Current Assets?
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Definition: A current asset, also called a current account, is either cash or a resource that are expected to be converted into cash within one year.
These resources are often referred to as liquid assets because they are so easily converted into cash in a short period of time. Take inventory for example. Inventory can easily be sold for cash in the next 12 months. Contrast that with a piece of equipment that is much more difficult to sell. Also, inventory is expected to be sold in the normal course of business for retailers. Equipment, on the other hand, are not.
This concept is extremely important to management in the daily operations of a business. As monthly bills and loans become due, management must convert enough current resources into cash to pay its obligations.
Management isn’t the only one interested in this category of assets, however. Investors and creditors use several different liquidity ratios to analyze the liquidity of the company before they invest in or lend to it. Investors want to know that their invest will continue to grow and the company will be able to pay returns in the future. Creditors, on the other hand, simply want to know that their principle will be repaid with interest.
Let’s take a look a few examples of current assets.
What is included in Current Assets?
Example List of Current Asset Types and Classes
There are many different assets that can be included in this category, but I will only discuss the most common ones.
Cash – Cash is all coin and currency a company owns. This includes all of the money in a company’s bank account, cash registers, petty cash drawer, and any other depository. This can include domestic or foreign currencies, but investments are not included.
Cash Equivalents – Cash equivalents are investments that are so closely related to cash and so easily converted into cash, they might as well be currency. An example of an equivalent is a US Treasury Bill. T-bills can be exchanged for cash at any point with no risk of losing their value.
Accounts Receivable – Accounts receivable is essentially a short-term loan to customers and vendors who purchase goods on account. Typically, customers can purchase goods and pay for them in 30 to 90 days. Accounts receivable keeps track of these loans.
Inventory – Inventory is the merchandise that a company purchases or makes to sell to customers for a profit. This could be anything from pencils to cars to houses. It depends on the business. For example, a car dealership is in the business of reselling cars. Thus, their cars are considered inventory, even though they have plenty of pencils in their offices.
Prepaid Expenses – Prepaid expenses are exactly what they sound like—expenses that have been paid before they were consumed. Insurance is a good example. A six-month insurance policy is usually paid for up front even though the insurance isn’t used for another six months. Even though these assets will not actually be converted into cash, they will be consumed in the current period.
Investments – Investments that are short-term in nature and expected to be sold in the current period are also included in this category. These typically include investments in stock called available for sale securities.
Notes Receivable – Notes that mature within a year or the current period are often grouped in the current assets section of the balance sheet.
Due from Officer Notes – Often times the officers or owners loan money to the company on a short-term basis. These 90-180 day loans are typically considered current.
How is Total Current Assets Calculated?
The total current assets formula is calculated by adding up the following types of assets:
- Cash
- Cash Equivalents
- Accounts Receivable
- Inventory
- Prepaid Expenses
- Investments
- Current Portion of Notes Receivable
- Current Portion Due from Officer Notes
How Are Current Assets Reported on Financial Statements
The balance sheet is a financial statement that reports the chart of accounts in order of the accounting equation: assets, liabilities, and equity. Current assets are always the first items listed in the assets section. They are also always presented in order of liquidity starting with cash.
Going back to our list of current assets, we would report them in this order: cash, accounts receivable, inventory, prepaid expenses, short-term investments, due from affiliates.
These assets are initially recorded at their fair market value or cost. For instance, cash and accounts receivable are recorded at their cash values. Inventory, on the other hand, is recorded at its cost.
It’s important for each of these accounts to be evaluated and adjusted throughout time with valuation accounts. For example, accounts receivable can become worthless over time if customers and vendors are unwilling or unable to make their payments. Thus, the receivables account must be adjusted to reflect the amount of receivables that management expects to convert into cash in the current period.
This concept is also true for inventory and investments. Overstating current assets can mislead investors and creditors who depend on this information to make decisions about the company.
Current Assets and Liquidity Ratios
Both investors and creditors look at the current assets of a company to gauge the value and risk involved in doing business with the company. They typically use liquidity ratios to compare the assets with liabilities and other obligations of the company. Some common ratios are the current ratio, cash ratio, and acid test ratio.
It’s important to note that the current assets definition is somewhat misleading for investors and creditors since not all of these assets are always liquid. For example, old, outdated inventory that can’t be sold isn’t that liquid. No one wants it.
The same is true for accounts receivable. If customers and vendors won’t pay their debts, the AR isn’t that liquid. This is another reason why management should always evaluate the current accounts for value at the end of each period.
Current vs Non-Current
The difference between current and non-current assets is pretty simple. Current assets are resources that are expected to be used up in the current accounting period or the next 12 months. Non-current assets, on the other hand, are resources that are expected to have future value or usefulness beyond the current accounting period. Some examples of non-current assets include property, plant, and equipment.
Here’s a current assets list with a little more information about how GAAP treats each account.
