What are Current Assets?

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Definition:

Current assets are anything of value that a company can reasonably expect to turn into cash within one year and are used to determine the liquidity of a company.

🤔 Understanding current assets

Current assets are resources that a company expects to sell or fully use for business operations within a year. A firm lists its current assets on its balance sheet and orders them by liquidity — first cash, then assets that can be converted into money within a year. Common current assets include cash, cash equivalents, short-term investments, net accounts receivable, prepaid expenses, and inventory. Depending on its industry, a company may or may not have some types of current assets. “Other current assets” often lumps together all other current assets that don’t fall into one of these categories. Current assets precede long-term assets on the balance sheet because the latter are less liquid, taking over a year to convert into cash.

Example

Let’s take a look at Tesla’s current assets on its company balance sheet for the quarter that ended December 31, 2019 (all values below are in millions):

Current assets: Cash and cash equivalents $6,268 Restricted cash $246 Accounts receivables, net $1,324 Inventory $3,552 Prepaid expenses and other current assets $713 Total current assets $12,103

(Source: Tesla Quarterly Reports)

Notice that Tesla doesn’t include in “current assets” any asset that would take longer than a year to convert into cash, including property, plant, and equipment.

Tesla owned total current assets valued at over $12.1 billion as of December 31, 2019, representing about 35.3% of its total assets.

Takeaway

A current asset is like water...

When somebody is thirsty, they’ll gladly take a glass of water. Water is relatively easy to find, and all you need to share it is a glass. Likewise, current assets are readily accepted and are easy to use and sell within a year. On the other hand, if you’re thirsty right now, you’ll hesitate to take a glass full of ice because it will take a while to become water, just like long-term assets can take longer than a year to produce value.

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What are current assets?

Current assets are company resources that generate a benefit or support operations, and that the firm can typically convert into cash within 12 months. Assets that take over 12 months to turn into cash are referred to as non-current assets or fixed assets. Like any asset, current assets have an assigned dollar value, which is recorded on the company’s balance sheet.

Companies need money to make money — raw materials for starting production of goods, bills due within 30 days, and cash for paying employees for their services are examples of short-term expenses that a company must meet. Current assets provide the cash flow to meet those expenses, so current assets are often referred to as “liquid assets.”

Current assets are useful to determine a company’s liquidity or solvency — a company’s ability to meet its current liabilities with current assets on hand. Company owners, creditors, financial analysts, and other stakeholders often use current assets and other items on the balance sheet to evaluate a company in a variety of ways.

Examples of current assets

Cash and other company assets that can be turned into cash within a year appear on the current assets section of a company’s balance sheet. Let’s take a look at Starbucks’ current assets on its balance sheet for the fiscal year that ended September 29, 2019 (all values below are in millions):

Current assets: Cash and cash equivalents $2,686.6 Short-term investments $70.5 Accounts receivables, net $879.2 Inventories $1,529.4 Prepaid expenses and other current assets $488.2 Total current assets $5,653.9

(Source: Starbucks Annual Reports)

Starbucks had a total of over $5.65 billion in current assets as of September 29,2019.

What are the components of current assets?

When it comes to paying bills right away, cash is king. However, there are also other components of current assets.

Cash equivalents

Cash equivalents are short-term investments that have a maturity date of three months or less.

Marketable securities

Marketable securities are financial instruments that can be easily converted to cash such as government bonds, common stock, or certificates of deposit. A company may classify a marketable security as a cash equivalent, and if the company chooses to do so, it needs to disclose in the footnotes sections of its balance sheet.

Accounts receivable

Accounts receivable is money your customers owe you for goods or services they’ve already received. The company agrees with the client on terms of credit, including maturity date, applicable interest rate, and discount for early payment.

Inventory

Inventory refers to raw materials, products currently under process, and finished goods that are almost ready for sale.

Short-term investments

Investments that a company can turn into cash within one to three years. Unlike long-term investments, short-term investments generally have a holding period of under 12 months, and the company intends to liquidate them within a full fiscal year.

Notes receivable

Notes receivable are often accounts receivable that received a time extension beyond the original deadline. For example, let’s assume that a company originally sold a vehicle to a client on credit due within 45 days. If the client is unable to pay back the accounts receivable at the end of the 45 days, the company may opt to issue the client a note payable. The company records the client’s note payable as a note receivable under its current assets.

Pre-paid expenses

A company may pay for expenses, such as rent and insurance, in advance and record those prepaid expenses as current assets on its balance sheet. Prepaid expenses have value and provide a future benefit that will be fully utilized within one year. The company keeps track of the use of prepaid expenses in its accounting journals and makes a footnote providing initial and final balances during an accounting period on its financial statements.

What items are current assets?

Here are the items that are typically included in each component of current assets.

Cash equivalents

  • Certificates of deposit (CDs)
  • Banker’s acceptances
  • Treasury bills (T-bills)
  • Commercial paper
  • Other money market financial instruments

Marketable securities

  • Short-term bonds issued by a private or public company
  • Common stock
  • Preferred stock

Accounts receivable

  • Accounts receivable
  • Trade receivable

Inventory

  • Raw materials
  • Products currently under process
  • Finished goods
  • Beginning inventory
  • Purchases
  • Ending inventory

Short-term investments

  • Cash equivalents and marketable securities with maturity dates of one to three years and that the company has earmarked to liquidate within a full fiscal year

Notes receivable

  • Promissory notes

Prepaid expenses

  • Prepaid rent
  • Prepaid insurance
  • Other prepaid expenses

What is the difference between current assets and non-current assets?

The difference between current assets and non-current assets is that current assets are expected to take less than a year to convert to cash, provide a future benefit, or be fully utilized.

Non-current assets take more than a year to convert to cash, provide a future benefit, or be fully utilized. Non-current assets are also known as fixed assets or long-term assets because they’re not readily converted to cash as current assets.

Some current assets may have a maturity date or useful life extending beyond 12 months, but a company may decide to record them as current assets in its balance sheet. By marking up these types of assets (e.g., short-term investments, notes receivable) as current assets, the company states that they will be fully utilized or turned into cash within 12 months.

A company can also record a portion of an asset as current and the remainder as non-current if its value extends beyond a year.

Suppose you were starting a new business, and you chose to pay your rent up-front for the next two years to guarantee you kept the retail space. The first 12 months of your prepaid rent would be recorded as a current asset, while the remainder would be considered a long-term asset.

What is the difference between current assets and current liabilities?

Current assets provide a future benefit (e.g., prepaid expense, capital gain, revenue) to the company, while current liabilities represent a future financial obligation (e.g., account payable, loan, debt) to the company.

Let’s use accounts receivable and accounts payable to provide a comparison.

An account receivable is a current asset that indicates that the company issued a credit to a client for the sale of goods or services. The company expects to receive cash within 12 months.

On the other hand, an account payable is a current liability that indicates that the company has to pay back debt within 12 months.

One similarity between current assets and current liabilities is their holding period. Current assets are sold, turned into cash, provide a future benefit, or fully utilized within 12 months, and current liabilities are paid within 12 months.

What are the uses of current assets?

Owners, analysts, creditors, and other stakeholders often use current assets to calculate financial ratios and evaluate a company. Current assets are helpful in determining the liquidity of a company in relation to its competitors and industry peers.

One example of a financial ratio using current assets is the current ratio, which measures the ability of a company to pay its short-term liabilities with its current assets.

The formula to calculate the current ratio is:

Other financial ratios measuring liquidity that use current assets include:

How do you calculate current assets?

The formula to calculate total current assets is:

Total current assets = cash and cash equivalents + short-term investments + net receivables + inventory + other current assets

Let’s take a look at Facebook’s current assets on its balance sheet for the fiscal year that ended December 31, 2019 (all values below are in millions):

Current assets: Cash and cash equivalents $19,079 Marketable securities $35,776 Accounts receivables, net $9,518 Prepaid expenses and other current assets $1,852 Total current assets $66,225

(Source: Facebook Annual Reports)

Facebook had a total of over $66.22 billion in current assets as of December 31, 2019.

From this example, you can see that not all companies will record on their balance sheets all of the items listed on the total current assets formula.

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