What Are Current Assets?
Current assets are cash and other resources that can be quickly converted to cash. From short-term investments to accounts receivable and inventory, current assets are ideal for a business that needs immediate cash in the short term.
Current assets can be understood better in contrast with fixed assets — any item or long-term investment that will not be consumed or sold during the fiscal year. Fixed assets are not intangible assets, and they tend to be essential to business operations; however, they have a longer duration than current assets, including short-term assets and finished products.
In a fiscal or financial year, one company may have a lot of cash from sales, while another company may use its cash to buy raw materials for production or finished goods for resale. A third company may use its cash for interest payments on debt. As a result, all three companies will have different balances in their current asset accounts at the end of an accounting period.
What Are Current Assets and How Do They Work?
Current assets are assets expected to be realized in cash, sold, or used during the normal operating cycle of the business. They typically include cash and cash equivalents, marketable securities, accounts receivable, and inventory. In some cases, prepaid expenses are also classified as current assets.
These assets are different from noncurrent assets, which are those that a company does not expect to turn into cash within a year. Current assets can indicate the company's ability to meet short-term obligations, and they are an important factor in a company's liquidity ratios.
Why Are Current Assets Important to a Company?
Current assets are important to a company because they represent the resources that can be used to generate cash in the short term. This is important because companies need cash to pay their bills, make investments, and grow their businesses.
The main purpose of classifying certain assets as current is to ensure that they are available to pay for short-term liabilities. A current ratio measures the company’s current assets against its short-term financial obligations, measuring total current assets in order of liquidity to paint a picture of the cash flow the company can generate. Quick ratios and cash ratios are similar but have slightly different formulas.
This is important because if a company cannot pay its debts when they come due, it will likely become insolvent. In addition, companies have to manage their current assets carefully because the assets play a vital role in the short-term success of the business.
While current assets are important for solvency purposes, they are not always the most important type of asset for a company. For example, if a company is expecting to grow rapidly in the near future, it may be more important to invest in long-term assets.
What Are the Different Types of Current Assets?
A company’s ability to pay bills is a vital component of its stability, and it is often the first line on the balance sheet and other financial statements. Keeping enough cash in the business can help it weather unexpected income interruptions, and it gives the business leverage. Current assets may vary from industry to industry, but they generally fall into the following categories:
- Cash equivalents
- Marketable securities
- Accounts receivable
- Short-term investments
- Other liquid assets
A company may have a mix of these types of current assets, and it should consider the amount of each. Another example of a current asset is prepaid expenses. These are expenses paid in advance, but will not be used until the period indicated.
Cash and Cash Equivalents
Cash equivalents are assets that can be quickly converted to cash. These include money market securities and treasury bills. Other liquid assets include precious metals like gold and silver, Treasury bills, investment-grade bonds, and stocks that are liquid, meaning that they can be sold fast.
However, the value of these assets may fluctuate with market conditions. As a result, a company may have $10 million in cash equivalents, but they’re not necessarily $10 million in “cash.” The company may need to sell some of the assets to convert them to cash.
Raw materials, work-in-progress, and finished goods are inventory. Inventory is a current asset only if a company has the capacity to convert it to cash. If a company doesn’t have the capacity to convert the inventory to cash, it is not a current asset.
For example, a car manufacturer may have an inventory of finished automobiles and engines. However, it can’t sell automobiles or engines until they have been delivered to the customer. As a result, the finished cars and engines are not current assets since they can’t be converted to cash.
Marketable securities are typically bought and sold through a market. Common examples of marketable securities include stocks, bonds, bills receivable, and money market instruments. These assets are usually held by the majority of companies and used to respond to sudden opportunities or unexpected expenses. Marketable securities help lenders assess whether a company is financially stable and can access capital quickly.
In addition, marketable securities can play a key role in financial ratio calculations. For example, the liquidity of a company is determined by how many of these assets are marketable. Marketable securities can be converted into cash in one year. They are listed in the current assets section of a company's balance sheet.
In contrast, marketable securities that are not listed on a market are listed in the noncurrent asset section of the balance sheet. Businesses generate marketable securities by setting aside cash to purchase liquid securities, like government bonds, in order to generate short-term interest.
Short-term debt securities are issued by public companies, and marketable debt securities are issued for a fixed amount of time, often one year or less. Liquidity is high among these investments, and they generally reach maturity within a year. Marketable securities are easy to sell and transfer, and they can be purchased in bulk by large financial entities.
Accounts receivable are amounts owed to a company by its customers for goods or services provided in the past. If a customer has a contract with a company and has been given credit, the amount of the contract is shown on the company’s books as an accounts receivable.
In addition, accounts receivable are current assets only if the company has a contractual right to collect payment. If the company doesn’t have a contractual right to collect a payment, the amounts owed are not current assets.
For example, a law firm may take a case on a contingent fee basis, which means the attorneys will be paid only if the client wins a settlement in court. The amount owed to the law firm for the services it has provided is an accounts receivable but is not a current asset because the amount is not guaranteed.
Short-term investments are resources that can be quickly converted to cash. They include money market funds, certificates of deposit (CDs), and short-term commercial paper. These short-term investments are generally very low risk.
It should be noted that short-term investments are current assets only if there is no contractual restriction on when they can be converted to cash. The investments might mature in less than one year.
What Are the Limitations of Current Assets?
Current assets are merely a short-term source of cash. For example, when a company buys inventory, it will have to pay the supplier within 30 days. The company may then sell the inventory to its customers, receiving cash, but it could be unable to collect payment from the customers.
As a result, current assets are only as good as the company’s ability to convert them to cash. It may be that the customers can’t afford to pay for the goods, or the supplier is unable to receive payment for the inventory. Current assets are also influenced by market conditions, such as supply and demand. If the economy goes into a recession, customers may have less money to spend and may be slow to pay their bills.
What Are the Key Takeaways in Regard to Current Assets?
Resources that can be quickly converted to cash and current assets include cash, accounts receivable, and inventory. Other types of assets that can be converted to cash encompass short-term investments and net working capital.
Current assets are important because they can be quickly converted to cash, making them useful for financing growth. In addition, they could offset the current liabilities. However, current assets ultimately have their limitations, as they are subject to economic factors and essentially only a means to quick cash.
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