Current Assets - Explained
What is a Current Asset?
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Table of ContentsWhat is a Current Asset?How are Current Assets Used?Key Components of Current AssetsExample of Current AssetsUses of Current AssetsRatios Using Current Assets or Their ComponentsAcademic Research on Current Assets
What is a Current Asset?
Current assets refer to the holdings of a company that can be easily converted to cash to fund the day-to-day operations of the business. Assets that can be sold within a period of one year are current assets. Assets that can also be used up through normal business operations or assets that can generate cash for the business over the next one year are current assets. Examples of current assets are liquid assets, cash, cash equivalents, marketable securities, stock inventory and accounts receivable. Generally, current assets are expected to be exhausted through the operations or normal business cycle of a company.
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How are Current Assets Used?
When recorded on a company's balance sheet, current assets are assets that appear for a duration not more than one year. They are assets that can be used to fund the operations of a business, they are often recorded in dollar value. The liquid assets of a company that can be easily converted to cash within a short period are current assets. Long-term assets on the other hand, cannot be converted into cash within the space of one year, these assets include, machinery and equipment, business facilities, and land. The inventory of a company for instance is an example of current asset, this is the stock of goods that a company has to sell to customers. When sold, the inventory of a company generate cash which is used in running other business operations.
Key Components of Current Assets
Liquid assets, cash, cash equivalents, marketable securities, inventory and prepaid liabilities are part of the current assets that a company has.
- Accounts Receivable: This refers to the amount of money that the customers of a company owe that are expected to be paid within a year such as money for goods purchased and services delivered. Companies that offer sales of product on credit to customers often have a backlog of accounts receivable.
- Inventory: The inventory of a business refers to the raw materials and finished products that a company has. These are current assets because the products can be sold within a space of one year and the raw materials also transformed to finished products. Inventory are often regarded as liquid assets because they can be converted to money easily.
- Prepaid Expenses: Prepaid expenses are money paid by a company to vendors for goods and services yet to be received but scheduled to be received in the future. Payments for inventory or company vendors for items that are yet to be delivered are also categorized as current assets.
When recorded on a companys balance sheet, current assets are ranked based on the order of their liquidity, that is, based on their chances of being converted to cash quickly. In most cases, cash often comes first when recording current assets on a companys balance sheet. The cash holdings of a company include petty cash, currency and checking accounts. After cash is recorded, other current assets such as cash equivalents, accounts receivable, prepaid expenses, inventory and marketable securities are recorded.
Example of Current Assets
Every company has current assets, whether little or huge, the current assets of a company are assets that can be converted to cash within a space of one year. A popular retail company in the US, Walmart Incs (WMT) had a total dollar amount of $59.66 billion as its current assets in January 2018, which was the end of its fiscal year. Also, in June 2018, Microsoft Corporation had a total of $169.66 billion.
Uses of Current Assets
The current assets of a company plays an important role in getting funds to run its day-to-day operations. A business is able to settle bills and other financial obligations with the aid of current assets. The current assets of calculated in dollar value in order to help a business trealine its operations and maximise all its potentials. The current assets of a company indicates how liquid a business is and the cash available for business operations. Generally, investors keep tabs on the value of the current assets of a company to determine whether it is safe for investment or otherwise.
Ratios Using Current Assets or Their Components
There are different metrics used in calculating the current assets of a company, diverse factors are put into consideration when using each of these metrics. The following are the common ratios used in measuring the liquidity of a firm;
- The quick ratio: this calculates the most liquid assets of the company and the ability of the company to settle its short-term obligations. The current assets of the company are calculated in relation to its current liabilities.
- The current ratio: this ratio measures a companys ability to pay both short and long-term debt obligations.
- The cash ratio: This ratio examines the ability of a company to make an immediate payment for all short-term liabilities.
Academic Research on Current Assets