Current assets is a concept associated with businesses. You will see this term in the balance sheet of the business.[i]So what does this term mean? What are current assets and what is its significance?
A current asset is cash or an asset like stock, which could be sold and converted to cash. This cash could be then used to clear the current liabilities.
The assets that could be sold or converted into cash, within a year’s time would be considered as current assets[ii].
Importance of current assets
When we talk of assets, there are two types – long-term assets, and current assets. Long-term assets are those like land, machinery, and facilities that are not liquid, which means it cannot be converted to cash within a year.
Current assets are liquid assets that can be liquidated or converted to cash within one year from the date shown in the balance sheet. It is important because it can be converted to cash and thus be used to take care of the requirement for day to day operations. It can also be used to pay operational expenses.
What are the current assets of a business?
The following are some of the current assets for a business[iii]:
- Cash: Cash refers to money that is kept as paper or coin money. It also refers to the money in the account and money orders. Generally, if a business has excess cash it is invested in liquid instruments like bank deposits, treasury bonds, or money market funds so that it can be converted to cash when required. These are cash equivalents.
- Accounts receivables: In accounting parlance, any credit to the customer is referred to as accounts receivables. What it means in simple terms, is that the product or service has been delivered to the customer, but payment is not yet received. So, this is receivable money, which is meant to be received shortly and is hence a current asset.
- Inventory: This is stock or the product and raw material available with the business. There are three types of inventory:
- Raw material inventory: This is the basic material needed to prepare a product.
- Work-in-progress inventory: This is the processed material used during production.
- Finished good inventory: This is the final product that is ready to be delivered to the customer.
- Prepaid expenses: These are advance payments made to vendors for materials, goods or services that are not yet received, but would be received in future. Now, this cannot be converted to cash, but it has already been paid. So, this is considered as current assets.
- Others: Other assets, if any, like advances to officers, prepaid pension costs, etc also need to be considered.
Current Assets = Cash + Accounts Receivables + Inventory + Prepaid Expenses + Other Assets
Current Assets and Liquidity[iv]
In the balance sheet, those assets that are more liquid, that is which can be easily converted to cash get higher priority while listing. Once your current asset value is determined, it can be used to calculate liquidity ratio, which is nothing but current assets divided by current liabilities. If the value is 1, then it indicates your liabilities are covered. If not, then it is a danger sign.
Current assets are nothing but those assets, which are liquid and can be easily converted to cash to meet your current liabilities. It is an important financial parameter for businesses.