Of all the items on a company's balance sheet, current assets are one of the most important. Current assets receive a lot of an owner's attention because these items represent the cash flow of the business. Money must flow through the cycle of inventory to receivables to cash for the company to have enough funds to pay its bills and operating expenses on a timely basis.
What are Current Assets?
Current assets are items on a company's balance sheet that are expected to convert into cash within one year. Assets that cannot be reasonably expected to turn into cash, such as buildings and equipment, are not included in the current assets category.
Current Assets Examples
The following items are examples of current assets:
- Cash: Checking accounts and petty cash.
- Cash equivalents: Government securities.
- Temporary investments: Certificates of deposit.
- Accounts receivable.
- Notes receivable maturing within one year.
- Inventory: Raw materials, work-in-progress, finished goods and supplies.
- Office supplies.
- Marketable securities.
- Prepaid expenses: Included because they will allow the company to avoid paying cash for these items during the upcoming year. Examples are insurance premiums.
- Other liquid assets readily convertible to cash: Income tax refunds, cash advances to employees and insurance claims.
What are Current Assets in Business?
Current assets represent the liquidity of a business. These assets are used to finance the daily operations and pay normal expenses. The ability of management to convert current assets into cash in a timely manner is a critical concern. On the balance sheet for a company, current assets are usually listed in order of liquidity; cash, of course, is the most liquid. The liquidity of inventory is murkier because of the various accounting methods of valuation.
Ratios With Current Assets
The current ratio of a business is one of the most important financial metrics used by owners and managers. It is calculated by dividing current assets by current liabilities. For example:
Current Ratio = Current Assets/Current Liabilities
A healthy current ratio is 2:1. This means that the company has $2 in current assets for each $1 in current liabilities.
A declining current ratio indicates that a business may soon start to have problems paying its bills on due dates.
The quick ratio is a harsher measure of liquidity. It is calculated by dividing cash plus accounts receivable by current liabilities.
Quick Ratio = (Cash + Accounts Receivable)/Current Liabilities
Current assets represent the monetary lifeblood of a business. Management has to pay special attention to the cash flow cycle of selling its products, collecting the receivables and investing the funds in more materials. The current asset ratios are important metrics for owners to monitor for any adverse trends in liquidity.