Current assets are one of the most important tools in a business’s arsenal because they facilitate activities that occur every day. This blog post examines what current assets are, how they’re calculated and why they’re important.
‘Current assets’ is a balance sheet term for liquid assets that can be expected to be converted into cash within one year. Or to put it another way, a current asset is any asset that is expected to be sold, consumed or otherwise exhausted during a business’s standard operations over the coming financial year.
Current assets are generally recorded on a balance sheet in order of liquidity with the assets that are more easily converted into cash placed higher up on the balance sheet.
Current assets provide the funds a business uses to pay for daily operational expenditures and other short-term operating expenses. If a business cannot pay these expenses, it will be unable to operate and will soon go out of business. And so current assets are vital for the daily health of all businesses.
Liquidity, which is a measure of a business’s ability to meet it’s immediate and short-term financial obligations, is heavily influenced by the ratio of current assets to current liabilities. Current assets also contribute to a business’s cash flow.
Creditors and investors will often pay close attention to a business’s current assets, cash flow and liquidity when they are assessing the value of and risks associated with investing in that business.
Current assets can be calculated by summing the value of each of the following:
Cash and cash equivalents
These are the most liquid current assets and thus will be at the top of any current assets list. This category includes currency notes, coins, undeposited cheques, petty cash, money in business bank accounts and money market accounts.
Marketable securities
Marketable securities are investments that will mature within a year. They’re a convenient way for businesses to store excess cash until it is required as the money invested in them is readily accessible while being exposed to minimal risk. These investments can provide greater returns than those afforded by high-interest bank savings accounts.
Accounts receivable
Accounts receivable is the term used to describe the value of a business’s unpaid invoices. Invoices with payment terms of less than a year are included in the current assets calculation.
If there is any doubt about whether a debtor will be able to settle an invoice, a ‘provision for doubtful debts’ or ‘bad debts’ account entry can be created. Such account entries give a more realistic view of the value of the accounts receivable.
The value of a business’s accounts receivable can be maximised through the use of good debt collection practices, easy invoice payment procedures and a careful assessment of the creditworthiness of potential debtors. Accounts receivable can also be converted to cash early, and practically immediately, though the use of invoice finance.
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Prepaid expenses
Any business expense that is paid for in advance is included in the current assets calculation under ‘prepaid expenses’ until the item expires. As the expiry date approaches, the asset is converted into an expense. Perhaps the most common examples of prepaid expenses are insurance and prepaid rent.
Inventory
Inventory or stock is generally the least liquid of the current assets. Many people think of inventory as being products awaiting sale but it also includes the raw materials required to make those products as well as any partially completed products.
The inventory values recorded on a balance sheet should take into account planned sales, any stock damage and fluctuating demand for products that may mean that a product doesn’t get sold.
Any other liquid assets
The above are the main types of liquid assets that are included the current assets calculation. Sometimes, however, a business may have other liquid assets that need to be accounted for. Examples include long-term investments with approaching dates of maturation and equipment that a business intends to sell.
Questions?
If you’re unsure whether something should be included in the current assets category on your balance sheet, pop a question in the comments below.
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FAQs
Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, pre-paid liabilities, and other liquid assets. The Current Assets account is important because it demonstrates a company's short-term liquidity and ability to pay its short-term obligations.
Does current assets include invoice? ›
For example, a fixed deposit of three months is a current asset. Trade debtors: Invoices pending collection, letters, and promissory notes are current assets since they must be paid quickly.
Why are net current assets important? ›
NCAs are important because they give lenders and investors an idea of how much working capital a company has on hand. Working capital is the money that a business has available to meet its short-term obligations, such as payroll or inventory costs.
What is the difference between current assets and non current assets? ›
Current assets are those that you can convert into cash within one year, such as short-term investments and accounts receivable. Non-current assets are longer-term assets with a full value that you cannot recognize until after one year, such as property and machinery.
What is the most important asset in accounting? ›
“Because assets are the business, cash obviously sits on top of the list of all assets, which are ordered by how easily they can be converted to cash.” A current asset can be converted into cash within one financial year or operating cycle.
What is the most important current asset? ›
Cash. Cash is the primary current asset, and it's listed first on the balance sheet because it's the most liquid. It includes domestic and foreign currency, a business checking account that's used to pay expenses and receive payments from customers, and any other cash on hand.
What should not be included in current assets? ›
1. Fixed Asset: These are tangible or long-term assets that include buildings, land, fixtures, equipment, vehicles, machinery, and furniture. Therefore, the term “current asset” does not include Furniture.
Which should not be considered as current asset? ›
Examples of noncurrent assets include long-term investments, land, property, plant, and equipment (PP&E), and trademarks. Current assets are most often valued at market prices, whereas noncurrent assets are valued at cost, less depreciation.
Are bills considered assets? ›
Personal assets are things of present or future value owned by an individual or household. Common examples of personal assets include: Cash and cash equivalents, certificates of deposit, checking, savings, and money market accounts, physical cash, and Treasury bills.
Is it good to have high non-current assets? ›
A company with strong non-current assets, such as valuable patents, may be more financially stable and have a better chance of sustaining long-term growth.
A current ratio that is lower than the industry average may indicate a higher risk of distress or default. Similarly, if a company has a very high current ratio compared with its peer group, it indicates that management may not be using its assets efficiently.
Is it good to have a lot of non-current assets? ›
Businesses typically hold non-current assets for long periods with the hope that the asset's value will increase over time. A company's list of non-current assets can help analysts measure its financial performance and where it's heading in the future.
What are the 7 current assets? ›
7 types of current assets
- Cash and cash equivalents.
- Marketable securities.
- Accounts receivable.
- Inventory.
- Supplies.
- Prepaid expenses.
- Other liquid assets.
In general, supplies are considered a current asset until the point at which they're used. Once supplies are used, they are converted to an expense.
Why are non-current assets important? ›
Non-current assets are assets and property owned by a business that are not easily converted to cash within a year. They may also be called long-term assets. Non-current assets are for long-term use by the business and are expected to help generate income.
Why is it important to have more current assets than current liabilities? ›
When a company has more current assets than current liabilities, it has positive working capital. Having enough working capital ensures that a company can fully cover its short-term liabilities as they come due in the next twelve months. This is a sign of a company's financial strength.
Why is it important to show current assets and current liabilities? ›
The ratio of current assets to current liabilities is important in determining a company's ongoing ability to pay its debts as they are due. Accounts payable is typically one of the largest current liability accounts on a company's financial statements, and it represents unpaid supplier invoices.
For what purpose are current assets held in the business? ›
In other words current assets are those assets which are held by the business with the purpose of converting them into cash within a short period, i.e., one year. For e.g., Debtors, Bill receivables, Stock etc.
Why is it important to manage current assets and current liabilities? ›
Working capital management aims at more efficient use of a company's resources by monitoring and optimizing the use of current assets and liabilities. The goal is to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations while maximizing its profitability.
