What are ‘Current Assets’
Current assets are balance sheet accounts that represent the value of all assets that can reasonably expect to be converted into cash within one year. Current assets include cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash.
In the United Kingdom, current assets are also known as current accounts.
BREAKING DOWN ‘Current Assets’
Current assets are important to businesses because they can be used to fund day-to-day operations and pay ongoing expenses. Depending on the nature of the business, current assets can range from barrels of crude oil, to baked goods, to foreign currency. On a balance sheet, current assets will normally be displayed in order of liquidity, or the ease with which they can be turned into cash.
Assets that cannot feasibly be turned into cash in the space of a year – or a business’ operating cycle, if it is longer – are not included in this category and are instead considered “long-term assets.” These also depend on the nature of the business, but generally include land, facilities, equipment, copyrights and other illiquid investments.
Accounts receivable, bills to customers that have yet to be paid, are considered current assets as long as they can be expected to be paid within a year. If a business has been making sales by offering loose credit terms, a chunk of its accounts receivables might not come due for a longer period of time. It is also possible that some accounts will never be paid in full. This consideration is reflected in an allowance for doubtful accounts, which is subtracted from accounts receivable. If an account is never collected, it is written down as a bad debt expense.
Inventory is included as current assets, but this item should be taken with a grain of salt. Different accounting methods can be used to inflate inventory, and in any case it is not nearly as liquid as other current assets. It may not even be as liquid as accounts receivable, which can be sold to third-party collection agencies in a pinch, albeit at a steep discount. Inventories tie up capital, and if demand shifts unexpectedly—which is more common in some industries than others—inventory can become backlogged. A seemingly healthy current assets balance can obscure a weak inventory turnover ratio and other problems.
Prepaid expenses are considered current assets not because they can be converted into cash, but because they are already taken care of, which frees up cash for other uses. As the year progresses, the value of prepaid expenses as assets decreases; they are amortized to reflect this fact. Prepaid expenses could include payments to insurance companies or contractors.
Components of current assets are used to calculate a number of ratios related to a business’ liquidity. The cash ratio is the most conservative: it divides cash and cash equivalents by current liabilities, and measures the ability of a company to pay off all of its short-term liabilities immediately.
The quick ratio or acid-test ratio is slightly less stringent: it adds cash and cash equivalents, marketable securities and accounts receivable, and divides the sum by current liabilities. This gives a more realistic picture of a company’s ability to meet its short-term obligations, but can be skewed by a backlog of accounts receivable.
The current ratio is the most accommodating: it divides current assets by current liabilities. It should be noted that in addition to accounts receivable, this measure includes inventories, so it probably overstates liquidity in many cases, especially for retailers and other inventory-intensive businesses.
In personal finance, current assets include cash on hand and in the bank, as well as marketable securities that are not tied up in long-term investments. In other words, current assets are anything of value that is highly liquid. Current assets can be used to pay outstanding debts and cover liabilities without having to sell fixed assets.