What is a Current Asset?
An asset is a resource owned or controlled by a business with the expectation of producing a future economic benefit. Businesses further categorize their assets on the balance sheet to current and non-current. If expected to be converted into cash, consumed through business operations or discharged in less than 12 months, then they are classified as current assets.
Non-current assets are different from current in the sense that they cannot feasibly be converted into cash within 12 months of acquisition. Some examples of non-currents assets are property, plant and equipment, and long-term assets.
Key Learning Points
- Current assets are resources controlled by an entity which are expected to be converted into cash, consumed through the business or discharged in less that 12 months
- The balance sheet reports assets in order of their liquidity i.e. how easily they can be converted into cash at no loss of value
- There are many items categorized as current asset with cash and cash equivalents being the most liquid
- Current assets are used in the calculation of liquidity ratios such as current ratio and quick ratio, which measures a company’s ability to cover its financial obligations using its current assets
What Items Usually Appear Under Current Assets?
- Cash and cash equivalents
- Accounts receivable
- Prepaid expenses
- Marketable securities
- Notes receivable
- Short-term investments
Let’s go into more detail with some of the items.
Cash and Cash Equivalents
Cash and cash equivalents include all cash and highly liquid assets with a short term to maturity (generally 90 days or 3 months).
Accounts receivable represents money that customers owe for products or services rendered. A company will reflect the owed amount under current assets if it expects to receive it within twelve months of the sale. When a company offers terms longer than 12 months to customers, a portion of the accounts receivable will not be included in current assets. There’s a possibility that some debtors will never settle their accounts. In that case, a company will write-off the outstanding amount to bad debts.
Inventory represents the cost of goods held for resale and consists of raw materials, work in progress (WIP) and finished goods.
Prepaid expenses consist of goods or services which have been paid for upfront and which the company expects to use within the next 12 months. A company cannot convert prepaid expenses into cash but to goods or services.
Some examples of marketable securities include banker’s acceptances, Treasury bills and shares.
An example of notes receivable is when a customer signs a promissory note to pay a loan.
Short-term investments include a certificate of deposit, mutual funds and Treasury bonds.
Calculation and Presentation in Financial Statements
Total Current Assets =
Cash and cash equivalents
+ Accounts receivable
+ Prepaid expenses
+ Short-term investments
+ Other current assets
Below shows an extract from the Coca-Cola company’s balance sheet:
The Coca-Cola Company – Balance Sheet Extract
Note that the assets are listed in order of liquidity, with cash and cash equivalents presented at the top and non-liquid current assets at the bottom. The total current assets line item is always reported at the bottom as the sum of the above values.
Ratios Using Current Assets
It measures a company’s ability to pay short-term and long-term obligations while considering the current assets relative to the current liabilities.
Current Ratio = Current Assets / Current Liabilities
Measures a company’s ability to settle short-term obligations with the most liquid assets. This formula does not consider inventory.
Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
Measures a company’s ability to meet short-term liabilities without having to sell or liquidate other assets since it uses cash.
Cash Ratio = Cash and Cash Equivalents / Current Liabilities
Practice calculating current assets in a downloadable Excel file.