The balance sheet of a company consists of three components - shareholders' fund, assets and liabilities. Instead, assets can be of different types, of which current asset is an important component.
Current assets are assets that can be easily converted into cash within one fiscal year.
Generally, current assets used for day to day business activities such as bills payment and short term debts payment etc. Current assets are liquid assets that can be readily converted into cash
What are Current Assets?
Current assets are those assets that are held and conveniently converted into cash within one fiscal year.
Current assets represent the assets of a company that are expected to be easily consumed, sold, used, or exhausted through business operations within one year.
Current assets could have included cash equivalents, cash, stock inventory, accounts receivable, marketable securities, and other liquid assets. Current assets are often called current accounts.
What are the components of current assets?
Cash, cash equivalents, and liquid investments in marketable securities, such as treasury bills or bonds, definitely would come under the current assets. However, the following are comprised of current assets too:
1. Inventory
Inventory is an accounting word that refers to the goods that are in different classes of being made for sale containing - raw materials, work in progress and finished goods.
Various accounting methods can be used to increase the inventory and many times, it may not be as a liquid asset as compared to other current assets being sure of on the product and the industry sector of the company.
For example, ABC Ltd is a textile manufacturing company. It furnishes cotton and other raw materials from different suppliers and transforms them into thread.
Suppose in the FY 2020-21 it bought cotton worth Rs 5 lakhs but only consumed 50% (Rs 2.5 lakh) of it for manufacturing and selling final goods. The rest of the unused cotton worth 2.5 lakh will be recorded as inventory.
2. Accounts Receivable
Accounts receivable is the amount of money owed by the company for delivering goods and services and the money will receive from its customers on account.
It is a norm in a few industries to sell goods and services on credit and the payment is expected to be received after a few weeks or months - which considering current assets in a specific fiscal year is recorded on the company's balance sheet.
In a business, a certain portion of the amounts that will be received in the future is recorded as accounts receivable but not be included in current assets.
Most of the time, some portion of money may never be paid in full. This consideration is an allowance for doubtful accounts, which is deducted from accounts receivable.
If a company never collects money from customers, it is considered a bad debt, and that entries are not considered current assets.
3. Prepaid Expenses
The term prepaid expenses refer to the advance payments made by a company for goods and services to be received in future and that is included in the current assets. But they cannot be converted into cash, their expenses are already paid for
Like any advance payment of rent or insurance premium, the legal expense is considered Prepaid expenses.
However, current assets generally represent the company's liquidity and are ready to convert into cash.
The order in which current assets are displayed is petty cash, cash at bank, cash in hand, cash advance, short term loan, short term investments, prepaid expense, inventory and accounts receivable.
Current Assets Formula
The current assets formula is the sum of total short term assets that can be considered into cash within a year. The current assets formula as follows-
Current Assets = Cash + Cash Equivalents + Inventory + Accounts Receivable + Marketable Securities + Prepaid Expenses + Other Liquid Assets
Where,
Cash = C
Cash Equivalents = CE
Inventory = I
Accounts Receivable = AR
Marketable Securities = MS
Prepaid Expenses = PE
Other Liquid Assets = OLA
Current Assets Example
In December company XYZ Ltd had -
Rs. 2,00,000 in cash
Rs. 2,00,000 in cash equivalents
Rs. 3,00,000 in marketable securities
Rs. 5,00,000 in accounts receivable
Rs. 2,50,000 in inventory
Rs. 1,00,000 in prepaid expenses
Rs. 2,00,000 in other liquid assets
Here's the balance sheet of company XYZ Ltd for 2020 as follows:
| Assets | Value (₹) |
| Current Assets | |
| Cash | ₹200,000 |
| Cash Equivalents | ₹200,000 |
| Marketable Securities | ₹300,000 |
| Accounts Receivable | ₹500,000 |
| Inventory | ₹250,000 |
| Prepaid Expenses | ₹100,000 |
| Other Liquid Assets | ₹200,000 |
Current Assets = Rs. 2,00,000 + Rs. 2,00,000 + Rs. 3,00,000 + Rs. 5,00,000 + Rs. 2,50,000 + Rs. 1,00,000 + Rs. 2,00,000
Current Assets = Rs. 17,50,000
Hence, the total current assets of XYZ Ltd in December 2020 would be = Rs. 17,50,000
Financial ratios using Current Assets and their components
Following are some liquidity ratios that measure the company's liquidity position. Each ratio has almost similar uses and uses several numbers of the company's current assets against the current liabilities.
1. Current Ratio
The current ratio helps to manage the liquidity position in the company. It measures how well a company maximizes the current assets or short term assets to fulfil its current debt and other payables.
Current Ratio = (Current Assets / Current Liabilities)
2. Quick Ratio
The quick ratio is an indicator of the short term liquidity position of a company and measures a company's ability to pay its short term obligations with the most liquid assets.
Quick Ratio = (current Assets - inventory - prepaid Expenses) / current Liabilities
The quick ratio is also known as the acid test ratio as well.
3. Cash Ratio
The cash ratio is also known as the super quick ratio that measures the cash position of the company to pay off immediate short term obligations.
The cash ratio is more conservative compared to other important liquidity ratios such as the current ratio & quick ratio
Cash Ratio = (Cash & Cash Equivalents / Current Liabilities)
Calculating the above ratios using current assets is exceptionally crucial to understand a company's capability to pay off short term liabilities as well as long term liabilities without selling any fixed assets.
Usage of Current Assets
The calculation of total current assets related to the day to day activities of the business is of extreme importance to the management of the company.
Most of the company's payments towards bills and loans become due at the end of every month, management must be prepared to spend the essential cash at that time.
The calculation of the current assets figure measures the company's liquidity position and assists the management to attempt necessary actions to continue business operations without any bother.
Even, the company's current assets or short term assets helps investors or creditors to analyze the value and risk involved in its operations of a business.
The current assets help to calculate different types of liquidity ratios and these ratios indicate a debtor's capacity to pay down their current debt obligations without taking external funds.
What are the differences between Current Assets and Non-Current Assets?
There are few differences between current assets and non-current assets as follows:
| Subject | Current Assets | Non-Current Assets |
| 1.Definition | Current assets are those assets that are readily converted into cash within one year. | Non-current assets are those assets that are held for more than one year and cannot very easily convert into cash. |
| 2.Components | Current assets include cash and cash equivalents, short term investments, accounts receivables, inventories, and prepaid revenue etc | Non-current assets consist of long term investments, plant property and equipment, goodwill, accumulated depreciation and amortization, and long term deferred taxes. |
| 3.Nature | Current assets are short term in nature. | Non-current assets are long term in nature. |
| 4.Valuation | Current assets are valued at market prices in the balance sheet. | Non-current assets are valued at the cost of less depreciation. |
| 5.Tax | The selling of the current assets results in the profit from trading activities. | The selling of non-current assets results in capital gains and capital gain tax is applicable. |
| 6.Revaluation | Generally, current assets are not subject to revaluation. | Revaluation of non-current assets such as PP&E is very common in this case. |
FAQs
1. What are the Current Assets examples?
Current assets can be recorded on the company's balance sheet. Few current assets examples as follows:
Cash and cash equivalents:
Cash and cash equivalents include cash in hand, money markets, and certificates of deposit.
Marketable securities:
Marketable securities consist of stocks or debt securities.
Accounts receivable:
Money owed to the company for selling their goods and services to their customers
Inventory:
The products that have been manufactured are available for sale.
Prepaid expenses:
The goods or services will be received shortly.
2. Is inventory a current asset?
Inventory is a current asset because inventory takes a long time to be converted into cash.
Inventory cannot be converted into cash as quickly as accounts receivable or marketable securities.
