Word of the Week 'Current Assets'


What are 'Current Assets'

Current assets is a balance sheet account that represents the value of all assets that can reasonably expect to be converted into cash within one year. Current assets include cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses. and other liquid assets that can be readily converted to cash.

In the United Kingdom, current assets are also known as current accounts.

BREAKING DOWN 'Current Assets'

Current assets are important to businesses because they can be used to fund day-to-day operations and pay ongoing expenses. Depending on the nature of the business, current assets can range from barrels of crude oil, to baked goods, to foreign currency. On a balance sheet, current assets will normally be displayed in order of liquidity, that is, the ease with which they can be turned into cash.

Assets that cannot feasibly be turned into cash in the space of a year – or a business' operating cycle, if it is longer – are not included in this category and are instead considered long-term assets. These also depend on the nature of the business, but generally include land, facilities, equipment, copyrights, and other illiquid investments.

Key Components of Current Assets

Accounts receivable, bills to customers that have yet to be paid, are considered current assets as long as they can be expected to be paid within a year. If a business has been making sales by offering loose credit terms, a chunk of its accounts receivables might not come due for a longer period of time. It is also possible that some accounts will never be paid in full. This consideration is reflected in an allowance for doubtful accounts, which is subtracted from accounts receivable. If an account is never collected, it is written down as a bad debt expense.

Inventory is included as current assets, but this item should be taken with a grain of salt. Different accounting methods can be used to inflate inventory, and in any case it is not nearly as liquid as other current assets. It may not even be as liquid as accounts receivable, which can be sold to third-party collection agencies, albeit at a steep discount. Inventories tie up capital, and if demand shifts unexpectedly, which is more common in some industries than others, inventory can become backlogged. A seemingly healthy current assets balance can obscure a weak inventory turnover ratio and other problems.

Prepaid expenses are considered current assets not because they can be converted into cash, but because they are already taken care of, which frees up cash for other uses. As the year progresses, the value of prepaid expenses as assets decreases; they are amortized to reflect this fact. Prepaid expenses could include payments to insurance companies or contractors.